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Master of Business Administration MBA Semester 4MB0037 International Business Management - 3 Credits

(Book ID: B0861)Assignment Set- 1

60 Marks

Note: Each question carries 10 Marks. Answer all the questions.

Q.1 a. How has liberalizing trade helped international business? (6 marks)

The Benefits of Trade LiberalizationPolicies that make an economy open to trade and investment with the rest of theworld are needed for sustained economic growth. The evidence on this is clear. Nocountry in recent decades has achieved economic success, in terms of substantialincreases in living standards for its people, without being open to the rest of theworld. In contrast, trade opening (along with opening to foreign direct investment)has been an important element in the economic success of East Asia, where the

average import tariff has fallen from 30 percent to 10 percent over the past 20 years.Opening up their economies to the global economy has been essential in enablingmany developing countries to develop competitive advantages in the manufacture ofcertain products. In these countries, defined by the World Bank as the "newglobalizers," the number of people in absolute poverty declined by over 120 million(14 percent) between 1993 and 1998.There is considerable evidence that more outward-oriented countries tendconsistently to grow faster than ones that are inward-looking. Indeed, one finding isthat the benefits of trade liberalization can exceed the costs by more than a factor of10. Countries that have opened their economies in recent years, including India,Vietnam, and Uganda, have experienced faster growth and more poverty reduction.

On average, those developing countries that lowered tariffs sharply in the 1980s grewmore quickly in the 1990s than those that did not. Freeing trade frequently benefits thepoor especially. Developing countries can ill- afford the large implicit subsidies, oftenchanneled to narrow privileged interests that trade protection provides. Moreover, theincreased growth that results from free trade itself tends to increase the incomes of thepoor in roughly the same proportion as those of the population as a whole. New jobs arecreated for unskilled workers, raising them into the middle class. Overall, inequalityamong countries has been on the decline since 1990, reflecting more rapid economicgrowth in developing countries, in part the result of trade liberalization. Thepotentialgains from eliminating remaining trade barriers are considerable. Estimate ofthegains from eliminating all barriers to merchandise trade range from US$250 billion toUS$680 billion per year. About two-thirds of these gains would accrue to industrialcountries. But the amount accruing to developing countries would still be more thantwice the level of aid they currently receive. Moreover, developing countries would gainmore from global trade liberalization as a percentage of their GDP than industrialcountries, because their economies are more highly protected and because they facehigher barriers. Although there are benefits from improved access to other countriesmarkets, countries benefit most from liberalizing their own markets. The main benefitsfor industrial countries would come from the liberalization of their agricultural markets.Developing countries would gain about equally from liberalization of manufacturing and

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agriculture. The group of low-income countries, however, would gain most fromagricultural liberalization in industrial countries because of the greater relativeimportance of agriculture in their economies.

b. What are the merits and demerits of international trade? (4 marks)

Sol.Advantages and Disadvantages of International Trade

Advantages to consider:

Enhance your domestic competitiveness

Increase sales and profits

Gain your global market share

Reduce dependence on existing markets

Exploit international trade technology

Extend sales potential of existing products

Stabilize seasonal market fluctuations

Enhance potential for expansion of your business

Sell excess production capacity

Maintain cost competitiveness in your domestic market

Disadvantages to keep in mind:

You may need to wait for long-term gains

Hire staff to launch international trading

Modify your product or packaging

Develop new promotional material

Incur added administrative costs

Dedicate personnel for traveling

Wait long for payments

Apply for additional financing

Deal with special licenses and regulations

Q. 2 Discuss the impact of culture on International Business. (10 marks)

SOL - In this new millennium, few executives can afford to turn a blind eye to globalbusiness opportunities. Japanese auto-executives monitor carefully what theirEuropean and Korean competitors are up to in getting a bigger slice of the Chineseauto-market. Executives of Hollywood movie studios need to weigh the appeal of an

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expensive movie in Europe and Asia as much as in the US before a firm commitment.The globalizing wind has broadened the mindsets of executives, extended thegeographical reach of firms, and nudged international business (IB) research into somenew trajectories. One such new trajectory is the concern with national culture.Whereas traditional IB research has been concerned with economic/ legal issues and

organizational forms and structures, the importance of national culture broadlydefined as values, beliefs, norms, and behavioural patterns of a national group hasbecome increasingly important in the last two decades, largely as a result of theclassic work of Hofstede (1980). National culture has been shown to impact on majorbusiness activities, from capital structure (Chui et al., 2002) to group performance(Gibson, 1999). For reviews, see Boyacigiller and Adler (1991) and Earley andGibson (2002).The purpose of this Unit is to provide a state-of-the-art review of several recentadvances in culture and IB research, with an eye toward productive avenues forfuture research. It is not our purpose to be comprehensive; our goal is to spotlight afew highly promising areas for leapfrogging the field in an increasingly boundary-lessbusiness world. We first review the issues surrounding cultural convergence anddivergence, and the processes underlying cultural changes. We then examine novelconstructs for characterizing cultures, and how to enhance the precision of culturalmodels by pinpointing when the effects of culture are important. Finally, we examinethe usefulness of experimental methods, which are rarely employed in the field ofculture and IB. A schematic summary of our coverage is given in Table 2.1, whichsuggests that the topics reviewed are loosely related, and that their juxtaposition inthe present paper represents our attempt to highlight their importance rather thantheir coherence as elements of an integrative framework.

1 Cultural change, convergence and divergence in an era of partial globalization

An issue of considerable theoretical significance is concerned with cultural changes

and transformations taking place in different parts of the world. In fact, since thelandmark study of Haire et al. (1966) and the publication of Industrialism andIndustrial Man by Kerr et al. (1960), researchers have continued to search forsimilarities in culture-specific beliefs and attitudes in various aspects of work relatedattitudes and behaviours, consumption patterns, and the like. If cultures of thevarious locales of the world are indeed converging (e.g., Heuer et al., 1999), IB-related practices would indeed become increasingly similar. Standard, culture-freebusiness practices would eventually emerge, and inefficiencies and complexitiesassociated with divergent beliefs and practices in the past era would disappear. In thefollowing section, we review the evidence on the issue and conclude that such anoutlook pertaining to the convergence of various IB practices is overly optimistic.

2 Evolution of partial globalization

Globalization refers to a growing economic interdependence among countries, asreflected in the increased cross-border flow of three types of entities: goods andservices, capital, and know-how (Govindarajan and Gupta, 2001, 4). Few spoke ofworld economy 25 years ago, and the prevalent term was international trade(Drucker, 1995). However today, international trade has culminated in the emergence

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of a global economy, consisting of flows of information, technology, money, andpeople, and is conducted via government international organizations such as theNorth American Free Trade Agreement (NAFTA) and the European Community; globalorganizations such as the International Organization for Standardization (ISO);multinational companies (MNCs); and cross border alliances in the form of joint

ventures, international mergers, and acquisitions. These inter relationships haveenhanced participation in the world economy, and have become a key to domesticeconomic growth and prosperity (Drucker, 1995, 153).Yet, globalization is not without its misgivings and discontents (Sassan, 1998). A vividimage associated with the G8 summits is the fervent protests against globalization inmany parts of the world, as shown in television and reported in the popular media.Strong opposition to globalization usually originates from developing countries thathave been hurt by the destabilizing effects of globalization, but in recent times wehave also seen heated debates in Western economies triggered by significant loss ofprofessional jobs as a result of off shoring to low wage countries. Indeed, workers inmanufacturing and farming in advanced economies are becoming increasingly wary ofglobalization, as their income continues to decline significantly. In parallel to theangry protests against globalization, the flow of goods, services, and investmentsacross national borders has continued to fall after the rapid gains of the 1990s.Furthermore, the creation of regional trade blocs, such as NAFTA, the EuropeanUnion, and the Association of Southeast Asian Nations, have stimulated discussionsabout creating other trade zones involving countries in South Asia, Africa, and otherparts of the world. Although it is often assumed that countries belonging to the WorldTrade Organization (WTO) have embraced globalization, the fact is that the world isonly partially globalized, at best (Schaeffer, 2003). Many parts of Central Asia andEastern Europe, including the former republics of the Soviet Union, parts of LatinAmerica, Africa, and parts of South Asia, have been sceptical of globalization(Greider, 1997). In fact, less than 10% of the worlds population is fully globalized

(i.e., being active participants in the consumption of global products and services)(Schaeffer, 2003). Therefore, it is imperative that we analyze the issues of culturalconvergence and divergence in this partially globalized world.

3 Role of multiculturalism and cultural identity

The broad ideological framework of a country, corporation, or situation is the mostimportant determinant of the cultural identity that people develop in a given locale(Triandis, 1994). The melting pot ideology suggests that each cultural group losessome of its dominant characteristics in order to become the mainstream: this isassimilation, or what Triandis (1994) calls subtractive multiculturalism.In contrast, when people from a cultural group add appropriate skills and

characteristics of other groups, it may be called integration, or additivemulticulturalism. Both of these processes are essential for cultural convergence toproceed. However, if there is a significant history of conflict between the culturalgroups, it is hard to initiate these processes, as in the case of Israelis andPalestinians. In general, although there has been some research on the typology ofanimosity against other nations (e.g., Jung et al., 2002), we do not know much abouthow emotional antagonism against other cultural groups affects trade patterns and

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intercultural cooperation in a business context. The issues of cultural identity andemotional reactions to other cultural groups in an IB context constitute a significantgap in our research effort in this area.

4 Implications of convergence and divergence issues

One message is clear: while convergence in some domains of IB activity is easilynoticeable, especially in consumer values and lifestyles, significant divergence ofcultures persists. In fact, Hofstede (2001) asserts that mental programs of peoplearound the world do not change rapidly, but remain rather consistent over time. Hisfindings indicate that cultural shifts are relative as opposed to absolute. Althoughclusters of some countries in given geographical locales (e.g., Argentina, Brazil, Chile)might indicate significant culture shifts towards embracing Anglo values, the changesdo not diminish the absolute differences between such countries and those of theAnglo countries (i.e., US, Canada, UK). Huntington, in his The Clash of Civilizations(1996), presents the view that there is indeed a resurgence of non-Western culturesaround the world, which could result in the redistribution of national power in theconduct of international affairs. The attempt by the Davos group to bring aboutuniform practices in various aspects of IB and work culture, thereby sustaining theforces of globalization, is certainly worthwhile. However, our analysis suggests thatthere is no guarantee that such convergence will come about easily, or without longperiods of resistance.IB scholars need to understand that although some countries might exhibit strongtendencies toward cultural convergence, as is found in Western countries, there arecountries that will reject globalization, not only because of its adverse economicimpacts (Greider, 1997) but also because globalization tends to introduce distortions(in their view) in profound cultural syndromes that characterize their nationalcharacter.

Q.3. a. Explain the brief structure of WTO. (5 marks)

Sol.

Structure of World Trade Organization (WTO)The WTOs overriding objective is to help trade flow smoothly, freely, fairly andpredictably.It does this by: Administering trade agreements Acting as a forum for trade negotiations

Settling trade disputes Reviewing national trade policies Assisting developing countries in trade policy issues, through technical assistanceand training programs Cooperating with other international organizations

Structure

The WTO has nearly 150 members, accounting for over 97% of world trade. Around 30

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others are negotiating membership.Decisions are made by the entire membership. This is typically by consensus. Amajority vote is also possible but it has never been used in the WTO, and wasextremely rare under the WTOs predecessor, GATT. The WTOs agreements havebeen ratified in all members parliaments.

The WTOs top level decision-making body is the Ministerial Conference which meetsat least once every two years.Below this is the General Council (normally ambassadors and heads of delegation inGeneva, but sometimes officials sent from members capitals) which meets severaltimes a year in the Geneva headquarters. The General Council also meets as theTrade Policy Review Body and the Dispute Settlement Body.At the next level, the Goods Council, Services Council and Intellectual Property

(TRIPS) Council report to the General Council.Numerous specialized committees, working groups and working parties deal withthe individual agreements and other areas such as the environment, development,membership applications and regional trade agreements.SecretariatThe WTO Secretariat, based in Geneva, has around 600 staff and is headed by adirector-general. Its annual budget is roughly 160 million Swiss francs. It does nothave branch offices outside Geneva. Since decisions are taken by the membersthemselves, the Secretariat does not have the decision-making role that otherinternational bureaucracies are given with. The Secretariats main duties are tosupply technical support for the various councils and committees and the ministerialconferences, to provide technical assistance for developing countries, to analyzeworld trade, and to explain WTO affairs to the public and media.The Secretariat also provides some forms of legal assistance in the dispute settlementprocess and advises governments wishing to become members of the WTO.the WTO is different from some other international organizations such

as the World Bank and International Monetary Fund. In the WTO, power is notdelegated to a board of directors or the organizations head.When WTO rules impose disciplines on countries policies, that is the outcome ofnegotiations among WTO members, the rules are enforced by the membersthemselves under agreed procedures that they negotiated, including the possibility oftrade sanctions. But those sanctions are imposed by member countries, andauthorized by the membership as a whole. This is quite different from other agencieswhose bureaucracies can, for example, influence a countrys policy by threatening towithhold credit.Reaching decisions by consensus among some 150 members can be difficult. Its mainadvantage is that decisions made this way are more acceptable to all members. And

despite the difficulty, some remarkable agreements have been reached. Nevertheless,proposals for the creation of a smaller executive body perhaps like a board ofdirectors each representing different groups of countries are heard periodically. Butfor now, the WTO is a member-driven, consensus-based organization.Highest authority: the Ministerial ConferenceSo, the WTO belongs to its members. The countries make their decisions throughvarious councils and committees, whose membership consists of all WTO members.Topmost is the ministerial conference which has to meet at least once every two

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years. The Ministerial Conference can take decisions on all matters under any of themultilateral trade agreements.Second level: General Council in three guisesDay-to-day work in between the ministerial conferences is handled by three bodies: The General Council

The Dispute Settlement Body The Trade Policy Review BodyAll three are in fact the same the Agreement Establishing the WTO states they areall the General Council, although they meet under different terms of reference.Again, all three consist of all WTO members. They report to the MinisterialConference.The General Council acts on behalf of the Ministerial Conference on all WTO affairs. Itmeets as the Dispute Settlement Body and the Trade Policy Review Body to overseeprocedures for settling disputes between members and to analyze members tradepolicies.Third level: councils for each broad area of trade, and more back to topThree more councils, each handling a different broad area of trade, report to theGeneral Council: The Council for Trade in Goods (Goods Council) The Council for Trade in Services (Services Council) The Council for Trade Related Aspects of Intellectual Property Rights (TRIPS

Council)As their names indicate, the three are responsible for the workings of the WTOagreements dealing with their respective areas of trade. Again they consist of all WTOmembers. These three also have the subsidiary bodies.

b. Highlight the drawbacks of GATT. (5 marks)Given its provisional nature and limited field of action, the success of GATT in

promoting and securing the liberalization of much of world trade over 47 years isincontestable. Continual reductions in tariffs alone helped spur very high rates ofworld trade growth around 8 per cent a year on average during the 1950s and 1960s.And the momentum of trade liberalization helped ensure that trade growthconsistently out-paced production growth throughout the GATT era. The rush of newmembers during the Uruguay Round demonstrated that the multilateral tradingsystem, as then represented by GATT, was recognized as an anchor for developmentand an instrument of economic and trade reform.The limited achievement of the Tokyo Round, outside the tariff reduction results, was

a sign of difficult times to come. GATTs success in reducing tariffs to such a lowlevel, combined with a series of economic recessions in the 1970s and early 1980s,drove governments to devise other forms of protection for sectors facing increasedoverseas competition. High rates of unemployment and constant factory closures ledgovernments in Europe and North America to seek bilateral market-sharingarrangements with competitors and to embark on a subsidies race to maintain theirholds on agricultural trade. Both these changes undermined the credibility andeffectiveness of GATT.

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Apart from the deterioration in the trade policy environment, it also becameapparent by the early 1980s that the General Agreement was no longer as relevant tothe realities of world trade as it had been in the 1940s. For a start, world trade hadbecome far more complex and important than 40 years before: the globalization ofthe world economy was underway, international investment was exploding and trade

in services not covered by the rules of GATT was of major interest to more andmore countries and, at the same time, closely tied to further increases in worldmerchandise trade. In other respects, the GATT had been found wanting: forinstance, with respect to agriculture where loopholes in the multilateral system wereheavily exploited and efforts at liberalizing agricultural trade met with little success and in the textiles and clothing sector where an exception to the normal disciplinesof GATT was negotiated in the form of the Multi-fibre Arrangement. Even theinstitutional structure of GATT and its dispute settlement system were giving causefor concern.Together, these and other factors convinced GATT members that a new effort toreinforce and extend the multilateral system should be attempted. That effortresulted in the Uruguay Round.

Q.4. a. Give a short note on the regional economic integration. (5 marks)

Regional Economic IntegrationRegional integration can take many forms, and nowhere is this more evident than inthe vastly different integration processes taking place in the regions of Europe andEast Asia. The subject of this paper is regional integration as it has developed in EastAsia with a focus on the drivers of that integration. While the paper is not intended asa direct comparison of integration in East Asia and Europe, it will include somecomparisons between the two regions.Integration in East Asia has progressed very slowly and is still in an early stage despitethat the process has continued for decades. In fact, it could be said that the processbegan centuries ago even as far back as the 15th century. By comparison, Europeanintegration has progressed steadily and has gradually deepened over the last 50 years

to reach an advanced stage today with a common currency and well-developedregional institutions. Thus, the speed of progression and the level of integrationattained in the two regions are quite dissimilar.In addition to these differences, the drivers behind the integration process in eachregion are different. In Europe, the origins of integration have been institutional innature, and the development of institutions has been prominent throughout theprocess. Thus, regional institutions have been the driving force behind integration inEurope. In East Asia, the development of regional institutions has also occurred;

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however, progress in this area has been slow and the few existing institutions arefairly weak and ineffective. Nevertheless, regional integration is taking place in EastAsia, but the driving force is the market rather than policy or institutions.Corporations and the production networks they have established are drivingintegration in East Asia.

b. Mention the benefits of WTO. (5 marks)

SOL- Ten Benefits of WTO1. The system helps to keep the peace2. The system allows disputes to be handled constructively3. A system based on rules rather than power makes life easier for all4. Freer trade cuts the cost of living5. It gives consumers more choice and a broader range of qualities to choose from6. Trade raises incomes

7. Trade stimulates economic growth and that can be good news for employment8. The basic principles make the system economically more efficient, and they cutcosts9. The system shields governments from narrow interests10. The system encourages good government

Q. 5 a. Explain five-element product wave model. (7 marks)

Sol. -

The Five-Element Product WaveAs illustrated in Figure 4.5, the wave model employs design engineering, processengineering, product marketing, production, and end-of-life activities as elements.The first wave is associated with the "A" version of a product or service, and survivesthrough the traditional PLC introduction and growth phases. A second wave beginswith the "B" version, the markedly improved second model. It starts just before thetraditional life cycle maturity stage and lives until sales decline to a point at which an

EOL decision must be made.Note that design engineering has a peak of activity level at each upgrade. Processengineering activity shadows that of design engineering, as system changes will becontemplated and made to facilitate the changes made in the product or service.Product marketing also has activity level spikes that closely match engineering designactivity, lagged somewhat for product introduction. Production has one activity peakthat results from demand management and production planning through masterproduction scheduling.

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Finally, the EOL curve peaks at each redesign. The last wave begins shortly beforeoriginal production ceases and ends when the product is no longer manufactured orsupported by the EOL Company or division. The EOL element requires that a decisionbe made about the preceding version at each major redesign: continue production,make a short-term run of spares, keep blueprints active so that parts can be made as

ordered, enter into a manufacturing and support agreement with another entity, ordiscontinue production.For the sake of parsimony, Figure 4.5 shows only a two-product model ("A" and "B"versions). In reality, there may be hundreds of significant redesigns. The wave effectcomes from the fact that the process repeats for the successful firm, forming swells indesign engineering, process engineering, product marketing, and manufacturingcurves before the final crest at EOL activity. The five-element product wave, or FPW,uses trigger points, rather than time, as the horizon over which the element curves vary.Changes in magnitude, represented by the vertical axis, result from differing activitylevels within the five elements. Simple changes in levels of dollar or unit product sales, inand of themselves, do not necessarily determine the trigger points. Rather, the varyingactivity levels are a direct result of product introductions and redesigns that, from theoutset, must take into account company strategy, core capabilities, and the state of thecompetitive environment. For example, a product with strong sales may be redesigned ina preemptive strike against competitors, further distancing that product from thecompetition, such as with Caterpillars innovative high-drive bulldozers.That the five-element wave is grounded in reality becomes apparent when consideringthe recent research that suggests product introduction cycles are being compressed.Bayus (1994) claims that knowledge is being applied faster, resulting in increasinglevels of new product introductions. Yet since product removals are not keeping pacewith introductions, there are an increasing number of product variations on themarket. Slater (1993) observes that product life cycles are growing shorter andshorter. Vesey (1992) reports that the strategy for the 1990s is speed to market and

discusses the pressures the market is exerting to shorten product introduction leadtimes. Regardless of whether life cycles are actually being compressed or knowledge issimply being applied faster, it is apparent that firms are increasing the speed withwhich they bring their products to market. The effect of this is a compression of thedesign engineering, process engineering, production, and product marketing elementsof the wave model. (The EOL curve may remain unchanged because acceleratedintroductions do not necessarily affect EOL efforts.) The five-element wave clearlyshows the inefficiency of traditional "over-the-wall" systems as speed to marketincreases. As the elements compress, more and more information is thrown over thewall. Recipients find themselves with less and less time to take action. Taken to theextreme, in-baskets, phone lines, conference rooms, desks, and floors are soon

gridlocked and littered with unanswered correspondence and things to do. Forgetquality; production itself grinds to a halt.The solution is to maximize the advantage of the relationships within the five-element wave and work in concurrent teams, as illustrated in Figure 6. That way,responsibility is shared throughout the system. Members from each discipline optimizethe system. The method tears down barriers between departments and speeds theintroduction process, thus decreasing costs. The focal point becomes the customer,rather than the task. The system is totally interactive and bound together. Each

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element is connected to all of the others and is focused on the customer. (Note thatthe authors have taken a great deal of artistic license here! No meaning should beattached to the actual measure of overlap area in Figure 4.6.)What is the recent experience with teams? There is evidence that using concurrentdesign teams speeds the product to market and provides substantial savings. Boeing

expects that concurrent design will save some $4 billion in the development of its 777airliner. Westinghouse recently suggested that concurrent engineering wouldeliminate 200 duplicate processes in a project that consisted of 600 using traditionalover-the-wall approaches. Fords Team Taurus was able to cut a full year out ofmodel turnaround. In addition, design changes required after initial production beganwere reduced by some 76 percent.The strength of the five-element product wave is the fact that it illuminates criticaldecision points in the life of a product or service. The interrelationships of theelements clearly illustrate the benefit of working product introductions, designchanges, and end-of-life decisions in teams. This is particularly true in todays rapidlycompressing environment of speeding products to market. Furthermore, the model isflexible and may be expanded or contracted to include those functional areasrelevant to the production team. Thus, whether a given firms product is a service ora manufactured good, the five-element wave is a powerful tool that can be deployedto accelerate effective decision making in markets demanding ever-increasing levelsof speed and agility.

b. What do you mean by globalization? (3 marks)Sol.

Economic "globalization" is a historical process, the result of human innovation andtechnological progress. It refers to the increasing integration of economies around theworld, particularly through trade and financial flows. The term sometimes also refers

to the movement of people (labor) and knowledge (technology) across internationalborders. There are also broader cultural, political and environmental dimensions ofglobalization that are not covered here.At its most basic, there is nothing mysterious about globalization. The term has comeinto common usage since the 1980s, reflecting technological advances that have madeit easier and quicker to complete international transactions both trade and financialflows. It refers to an extension beyond national borders of the same market forces thathave operated for centuries at all levels of human economic activity villagemarkets, urban industries, or financial centers.Markets promote efficiency through competition and the division of labor thespecialization that allows people and economies to focus on what they do best. Global

markets offer greater opportunity for people to tap into more and larger marketsaround the world. It means that they can have access to more capital flows,technology, cheaper imports, and larger export markets. But markets do notnecessarily ensure that the benefits of increased efficiency are shared by all.Countries must be prepared to embrace the policies needed, and in the case of thepoorest countries may need the support of the international community as they do so.

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Q. 6. Give some examples of companies doing international business and discusshow they have they have managed their business in the international markets. (10marks)

Sol.

A PERSPECTIVE OF THE NORTHEN ISLAND SOFTWARE COMPANIES, RAPD MUP

Within six months of announcing it would invest $4.5 million to establish its newsoftware development center in Northern Ireland, IMR was up and running with morethan one-third its target staff. "The fast start-up of the Belfast facility reaffirms ourconfidence to locate in Northern Ireland," said Sanan. "The success to date in building aquality work force has surpassed our expectations and opens up new ambitions for ourinterests in Northern Ireland." According to Arthur "Bro" McFerran, president of IMR (NI)Ltd., the company is hiring 12 to 18 programmers a month in Northern Ireland and is well

on its way to meeting its staffing goal of 300 by 1999. McFerran credited NorthernIrelands Training & Employment Agency (T&EA) with helping place the companysstaffing on the fast track. "The T&EA not only has helped us to identify and recruitqualified software graduates from Northern Irelands universities, it is also assisting uswith a unique initiative to bring additional sources of high quality talent to the company,"McFerran said. Innovation In Training Impressed by the number and quality ofinformation technology graduates from the regions universities, IMR recognized anuntapped resource in the well-educated, versatile graduates of other fields in NorthernIreland. Working with the T&EA, IMR developed "IMR Academy," an intensive 20-weektraining program at the Belfast Institute of Further and Higher Education, to expand theskills of qualified applicants who are not computer software graduates, but who are

equally well-educated in other Disciplines and who have demonstrated aptitude forlearning computer software programming. Tom Scott of the T&EA said IMR applicantsare assessed throughout the program and those who successfully complete the courseare awarded a National Computing Certificate and full-time employment with IMR.Approximately 40 trainees have already participated in the program. "IMR is extremelypleased with the T&EAs ability to design and deliver a training program customized toour needs, and one that is delivering us an impressive pool of incremental programmingtalent," McFerran said. Smart And Available "The recent software investments by IMRand other companies provide a new opportunity for Northern Irelands computergraduates," McFerrin said. Recruitment research by IMR indicates that traditionally,nearly half of the regions computer graduates have been forced to seek jobs outsideNorthern Ireland due to the lack of available information technology positions.Now IT graduates have the chance to find good jobs in Northern Ireland, andgraduates from other fields can take advantage of the IMR Academy training programto get a head start on a career in the growing software sector.McFerrin said. Recruitment research by IMR indicates that traditionally, nearly half ofthe regions computer graduates have been forced to seek jobs outside NorthernIreland due to the lack of available information technology positions.

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Competitive Advantage

Northern Ireland recently has attracted information technology based investmentsfrom other multinational companies such as BT, Fujitsu, Liberty Mutual Group,Seagate Technology, STB Systems and UniComp. These companies cite NorthernIrelands work force and favorable cost base in their decisions to locate in the region.

"The availability of high-quality graduates combined with the regions competitiveoperating costs and attractive incentives made Northern Ireland the best possiblelocation for STB," said Richard W. Cooke, STBs director of engineering operations.With salaries and fringe costs for well trained software engineers in Northern Irelandapproximately 50 percent lower than costs for US engineers, and low employeeturnover and favorable rates for office space, the overall annual per capitaoperational costs to develop high quality software can be significantly less comparedwith these same costs in the United States.Typical starting salaries for IT graduates in Northern Ireland are $22,000 to $25,000annually. At less than three percent annually, Northern Irelands employee turnoverrate is a fraction of the rates typically experienced in other parts of Europe and theUnited States. Annual costs per square foot for office space, exclusive of propertytaxes and service charges, range from as low as $5 per square foot in somedevelopment areas, to approximately $14 in Belfast. These costs can be as much as 50percent lower than office space costs in other European cities.

Master of Business Administration - MBA Semester 4

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MB0037 International Business Management - 3 Credits(Book ID: B0861)

Assignment Set- 260 Marks

Note: Each question carries 10 Marks. Answer all the questions.

Q.1 Evaluate the monetary system and currency markets in international businessmanagement. (10 marks)Sol.

The IMF is an international organization of 185 member countries. It was establishedto promote international monetary cooperation, exchange stability, and orderlyexchange arrangements; to foster economic growth and high levels of employment;and to provide temporary financial assistance to countries to help ease balance ofpayments adjustment.The International Monetary Fund (IMF) is the intergovernmental organization thatoversees the global financial system by following the macroeconomic policies of its

member countries, in particular those with an impact on exchange rate and thebalance of payments. It is an organization formed with a stated objective ofstabilizing international exchange rates and facilitating development through theenforcement of liberalising economic policies[1][2] on other countries as a condition forloans, restructuring or aid.[3] It also offers highly leveraged loans, mainly to poorercountries. Its headquarters is in Washington, D.C., United States.Organization and purposeIMF "Headquarters 1" in Washington, D.C. The International Monetary Fund was createdin July 1945, originally with 45members,[4] with a goal to stabilize exchange rates andassist the reconstruction of the world's international payment system. Countriescontributed to a pool which could be borrowed from, on a temporary basis, by countries

with payment imbalances (Condon, 2007). The IMF was important when it was firstcreated because it helped the world stabilize the economic system. The IMF works toimprove the economies of its member countries.[5] The IMF describes itself as "anorganization of 187 countries (as of July 2010),[6][7] working to foster global monetarycooperation, secure financial stability, facilitate international trade, promote highemployment and sustainable economic growth, and reduce poverty". With the exceptionof Cuba (left in 1964),[8] Taiwan (expelled in 1980),[9] North Korea, Andorra, Monaco,Liechtenstein, Tuvalu and Nauru, all UN member states participate directly in the IMF.Member states are represented on a 24-member Executive Board (five ExecutiveDirectors are appointed by the fivemembers with the largest quotas, nineteen Executive Directors are elected by theremaining members), and all members appoint a Governor to the IMF's Board ofGovernors.[1

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Q.2 a. Mention the different entry strategies to enter international markets. (4marks)Sol.

Entry StrategiesMethods of entryWith rare exceptions, products just dont emerge in foreign markets overnight a firmhas to build up a market over time. Several strategies, which differ in aggressiveness,risk, and the amount of control that the firm is able to maintain, are available: Exporting is a relatively low risk strategy in which few investments are made in thenew country. A drawback is that, because the firm makes few if any marketinginvestments in the new country, market share may be below potential. Further, thefirm, by not operating in the country, learns less about the market (What doconsumers really want? Which kinds of advertising campaigns are most successful?What are the most effective methods of distribution?) If an importer is willing to do agood job of marketing, this arrangement may represent a "win-win" situation, but itmay be more difficult for the firm to enter on its own later if it decides that largerprofits can be made within the country.

Licensing and franchising are also low exposure methods of entry you allowsomeone else to use your trademarks and accumulated expertise. Your partner putsup the money and assumes the risk. Problems here involve the fact that you aretraining a potential competitor and that you have little control over how the businessis operated. For example, American fast food restaurants have found that foreignfranchisees often fail to maintain American standards of cleanliness. Similarly, aforeign manufacturer may use lower quality ingredients in manufacturing a brandbased on premium contents in the home country. Contract manufacturing involves having someone else manufacture products whileyou take on some of the marketing efforts yourself. This saves investment, but againyou may be training a competitor.

Direct entry strategies, where the firm either acquires a firm or builds operations"from scratch" involve the highest exposure, but also the greatest opportunities forprofits. The firm gains more knowledge about the local market and maintains greatercontrol, but now has a huge investment. In some countries, the government mayexpropriate assets without compensation, so direct investment entails an additionalrisk. A variation involves a joint venture, where a local firm puts up some of themoney and knowledge about the local market.

b. How has E-commerce helped in international marketing? (6 marks)

Sol.Electronic Commerce

1 Prospects for electronic commerce

Electronic commerce usually in the form of sales, promotion, or support through theInternet is a hot topic at the moment, evidenced by the high market capitalizationof firms involved in this kind of business. Growth rates have been considerable overthe last two years and are expected to persist, at least to some extent, for at leastthe next several years. Yet, it should be recognized that so far, sales over the

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Internet account for only a small portion of sales especially outside the U.S.

2 Obstacles to diffusion

Obstacles to the diffusion of Internet trade come both from enduring sources andtemporary roadblocks which may be overcome as consumer attitudes change andtechnology is improved. Currently, Internet connections are slower than desired so

that downloading pictures and other information may take longer than consumers arewilling to wait. "Glitches" in online ordering systems may also frustrate consumers,who are unable to place their orders at a given time or have difficulty navigatingthrough a malfunctioning site. The lack of non-English language sites in some areasmay also be off-putting to consumers, and registering domain names in somecountries is difficult. Further, shipping small packages across countries may beinefficient due to high local postage rates and inefficiencies in customs processing.Most of these obstacles may be overcome within next few years.Other obstacles may, however, have considerably greater staying power. First, thereare legal problems, as several different countries may seek to impose theirjurisdiction on advertising and laws of product assortment and business practices.Further, the maintenance of databases, which are essential to delivering on thepromises of e-commerce, may conflict with the privacy rules of some countries this iscurrently a hot issue of contention between the United States and the EuropeanUnion. Finally, there are issues of taxation and collection. While the ClintonAdministration has sought to get the WTO to go along with a three year tax"moratorium" on Internet purchases much like the one observed in the U.S., strongopposition is expected. A great attraction of e-commerce in Europe is that peoplemay order from other countries and thus evade local sales taxes, which can beprohibitive (e.g., 25% in Denmark and 16% in Germany). Some firms will ship tocustomers in neighbouring countries without collecting sales taxes or duties, with theresponsibility of paying falling on the consumer. Although most consumers who orderand do not arrange to pay for these taxes get away with it, fines for those caught

through random checks can be severe.3 Locus of the site

Some firms have chosen to maintain a global site, with reference only to local sales orsupport offices; others, in contrast, have unique sites for each country. In some cases,global sites will hyperlink surfers to a country or region relevant to the site. Note thatsome confusion exists since many sites outside the U.S. maintain the ".com"designation rather than their countries respective suffix (e.g., ".de" for Germany,".se" for Sweden, and ".au" for Australia). Some firms have experienced problemsgetting their banks to accept credit card charges in more than one currency, and thusit may be difficult to indicate precise prices in more than one denomination (one sitebased in Britain offered its American customers to be as accurate as possible, based

on current exchange rates, although the charge could be off "by a few pennies.")4 Lifecycle stages across the World

It has been suggested that Europe runs some five years behind the U.S. in electroniccommerce, but some sources dispute this, suggesting that lack of success amongAmerican retailers may have other origins, such as inadequate adaptation (forexample, some British users are put off by American English). There are, however,some factors which cause most countries run behind. Even in Europe, Internet accesspenetration rates are lower than they are in the U.S., and the slower speed

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associated with downloading Asian characters is discouraging. In some countries,credit card penetration is lower, and even in European countries with highpenetration rates, consumers are reluctant to use them. Further, the fact thatconsumers in most countries have to pay a per minute phone charge discourages theessential casual and relaxed browsing common in the U.S. so long as unlimited cable

or hardwired access is not offered.

Q.3 a. Explain Bill of Lading and Letters of credit. (8 marks)Sol.

A bill of lading (sometimes referred to as aBOL,orB/L) is a document issued by acarrier to a shipper, acknowledging that specified goods have been received on boardas cargo forcon v eyan ce to a named place for delivery to thecon s ign ee who is usuallyidentified. Athorough bill of lading involves the use of at least two different modes

of transport from road, rail, air, and sea. The term derives from the verb "to lade"which means to load a cargo onto a ship or other form of transportation.A bill of lading can be used as a traded object. The standard short form bill of ladingis evidence of thecon t r act of carriage of goods and it serves a number of purposes:

It is evidence that a valid contract of carriage, or a chartering contract, exists,and it may incorporate the full terms of the contract between the consignorand the carrier by reference (i.e. the short form simply refers to the maincontract as an existing document, whereas the long form of a bill of lading(connaissement intgral) issued by the carrier sets out all the terms of thecontract of carriage);

It is a receipt signed by the carrier confirming whether goods matching thecontract description have been received in good condition (a bill will bedescribed asclean if the goods have been received on board in apparent goodcondition and stowed ready for transport); and

It is also a document of transfer, being freely transferable but not an egot iableinstrument in the legal sense, i.e. it governs all the legal aspects of physicalcarriage, and, like acheque or other negotiable instrument, it may beendorsed affecting ownership of the goods actually being carried. This matcheseveryday experience in that the contract a person might make with acommercial carrier like FedEx for mostly airway parcels, is separate from anycontract for the sale of the goods to be carried; however, it binds the carrier

to its terms, irrespectively of who the actual holder of the B/L, and owner ofthe goods, may be at a specific moment.

A standard, commercial letter of credit is a document issued mostly by afinancial institution, used primarily in trade finance, which usually provides anirrevocable payment undertaking.

The letter of credit can also be source of payment for a transaction, meaningthat redeeming the letter of credit will pay an exporter. Letters of credit areused primarily in international trade transactions of significant value, for deals

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between a supplier in one country and a customer in another. They are alsoused in the land development process to ensure that approved public facilities(streets, sidewalks, storm water ponds, etc.) will be built. The parties to aletter of credit are usually abeneficiary who is to receive the money, the

issuing bank of whom the applicant is a client, and the advising bank of whom

the beneficiary is a client. Almost all letters of credit are irrevocable, i.e.,cannot be amended or canceled without prior agreement of the beneficiary,the issuing bank and the confirming bank, if any. In executing a transaction,letters of credit incorporate functions common to giros and Traveler's cheques.Typically, the documents a beneficiary has to present in order to receivepayment include a commercial invoice, bill of lading, and documents provingthe shipment was insured against loss or damage in transit. However, the listand form of documents is open to imagination and negotiation and mightcontain requirements to present documents issued by a neutral third partyevidencing the quality of the goods shipped, or their place of origin.

b. What is UNCITRAL and what it does? (2 marks)SOL - The United Nations Commission on International Trade Law

(UNCITRAL) wasestablished by the United Nations General Assembly by its Resolution 2205 (XXI) of 17December 1966 "to promote the progressive harmonization and unification ofinternational trade law.When world trade began to expand dramatically in the 1960s, national governmentsbegan to realize the need for a global set of standards and rules to harmonizenational and regional regulations, which until then governed

Q.4. Explain the importance of STP in international markets. (10 marks)Sol.The importance of STPSegmentation is the cornerstone of marketing almost all marketing efforts in someway relate to decisions on who to serve or how to implement positioning through thedifferent parts of the marketing mix. For example, ones distribution strategy shouldconsider where ones target market is most likely to buy the product, and apromotional strategy should consider the targets media habits and which kinds ofmessages will be most persuasive. Although it is often tempting, when observing largemarkets, to try to be "all things to all people," this is a dangerous strategy becausethe firm may lose its distinctive appeal to its chosen segments.In terms of the "big picture," members of a segment should generally be as similar aspossible to each other on a relevant dimension (e.g., preference for quality vs. lowprice) and as different as possible from members of other segments. That is, membersshould respond in similar ways to various treatments (such as discounts or highservice) so that common campaigns can be aimed at segment members, but in orderto justify a different treatment of other segments, their members should have their

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own unique response behaviour.

The importance of STP

Segmentation is the cornerstone of marketing almost all marketing efforts in some

way relate to decisions on who to serve or how to implement positioning through thedifferent parts of the marketing mix. For example, ones distribution strategy shouldconsider where ones target market is most likely to buy the product, and apromotional strategy should consider the targets media habits and which kinds ofmessages will be most persuasive. Although it is often tempting, when observing largemarkets, to try to be "all things to all people," this is a dangerous strategy becausethe firm may lose its distinctive appeal to its chosen segments.In terms of the "big picture," members of a segment should generally be as similar aspossible to each other on a relevant dimension (e.g., preference for quality vs. lowprice) and as different as possible from members of other segments. That is, membersshould respond in similar ways to various treatments (such as discounts or highservice) so that common campaigns can be aimed at segment members, but in orderto justify a different treatment of other segments, their members should have theirown unique response behaviour.

Q. 5 a. Write a short note on branding and trademarks. (6 marks)

Sol.

Branding and trademarksAs mentioned in chapter four, it is difficult to protect a trademark or brand, unless allcountries are members of a convention. Brand "piracy" is widespread in manydeveloping countries. Other aspects of branding include the promotional aspects. A

family brand of products under the Zeneca (ex ICI) label or Sterling Health are likely tobe recognised worldwide, and hence enhance the "subjective" product characteristics.Warranty Many large value agricultural products like machinery require warranties.Unfortunately not everyone upholds them. It is common practice in Africa that if theoriginal equipment has not been bought through an authorized dealer in the country,that dealer refuses to honour the warranty. This is unfortunate, because not only maythe equipment have been legitimately bought overseas; it also actually builds upconsumer resistance to the dealer. When the consumer is eventually offered with achoice, the reticent dealer will suffer, for example, with the new dealers coming up.Cotton Production/Marketing Interface Spinners Machines are highly flexible, that is theycan usually switch to a variety of yarn requirements. The machines are geared to high

production, are automated and are of a precision for constant quality provision. Thereare strict process controls and built n quality control. Poor raw material, especiallywhen contaminated with metal particles, damages opening mills, grid knives, fans andcard clothing. Previous devices employed to remove these (magnets) are becoming lesseffective. The consequences are damage in the blow room and carding and danger offire. Quality is therefore defined as properties of the end use (clothing etc.), efficiency ofweaving and knitting and the efficient running of the spinning plant. Spinners require rawcotton which is free of trash; dust, sugar and honey dew contamination, seed coats, bark

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and foreign fibres and, will not nep the cloth. Further requirements are a certain length(could be short, medium or long), uniformity of length, strength, fineness, maturity and acertain elongation and colour. Suppliers In order to meet these high quality demands,the growers have to ensure that the production, picking and ginning is of a very highstandard. Cotton grading The Liverpool Cotton exchange, for one, relied on the skills of

its experts to manually classify raw fibre purchases for its clients. It still holds the"standards" for length, colour and trash content. As well as the demands of modemmachinery, the lack of standardised measuring and cotton classification procedures hasresulted in commercial conflict and legal disputes about the true nature of traded cotton.Now, computer based high volume instrument listing systems of raw cotton (HVIsystems) are available. The system can handle large numbers of bales, reduce variationin classification and the need for highly trained bate classifiers.For cotton exporters the system offers the following advantages:

enhanced objectivity in classification

improve communication if similar systems are used by sellers or buyers

reduced conflict and need for arbitration

enhanced competitiveness against synthetic fibres improved integration with modern spinning machines

reduced costs on training of experts and in measuring time.The system can process 2000 bales per day and give a printout on the sevenparameters of grading. These include length and length uniformity, strength andelongation, micronaire or fineness, leaf and colour. Manufacturers include SPINLARINC. of Knoxville, USA.

b. What are the features of exchange and currency markets? (4 marks)

Sol.The exchange rate regimes adopted by countries in todays international monetaryand financial system, and the system itself, are profoundly different from thoseenvisaged at the 1944 meeting at Bretton Woods establishing the IMF and the WorldBank. In the Bretton Woods system: exchange rates were fixed but adjustable. This system aimed both to avoid theundue volatility thought to characterize floating exchange rates and to preventcompetitive depreciations, while permitting enough flexibility to adjust tofundamental disequilibrium under international supervision; private capital flows were expected to play only a limited role in financing paymentsimbalances, and widespread use of controls would prevent instability in such flows;

temporary official financing of payments imbalances, mainly through the IMF, wouldsmooth the adjustment process and avoid unduly sharp correction of current accountimbalances, with their repercussions on trade flows, output, and employment.In the current system, exchange rates among the major currencies (principally theU.S. dollar, the euro, and Japanese yen) fluctuate in response to market forces, withshort-run volatility and occasional large medium-run swings (Figure 1). Some medium-sized industrial countries also have market determined floating rate regimes, whileothers have adopted harder pegs, including some European countries outside the euro

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area. Developing and transition economies have a wide variety of exchange ratearrangements, with a tendency for many but by no means all countries to movetoward increased exchange rate flexibility (Figure 2).This variety of exchange rate regimes exists in an environment with the followingcharacteristics:

partly for efficiency reasons, and also because of the limited effectiveness of capitalcontrols, industrial countries have generally abandoned such controls and emergingmarket economies have gradually moved away from them. The growth ofinternational capital flows and globalization of financial markets has also beenspurred by the revolution in telecommunications and information technology, whichhas dramatically lowered transaction costs in financial markets and further promotedthe liberalization and deregulation of international financial transactions; internationalprivate capital flows finance substantial current account imbalances,but the changes in these flows appear also sometimes to be a cause ofmacroeconomic disturbances or an important channel through which they aretransmitted to the international system;

developing and transition countries have been increasingly drawn into theintegrating world economy, in terms of both their trade in goods and services and offinancial transactions.Lessons from the recent crises in emerging markets are that for such countries withimportant linkages to global capital markets, the requirements for sustaining peggedexchange rate regimes have become more demanding as a result of the increasedmobility of capital. Therefore, regimes that allow substantial exchange rate flexibilityare probably desirable unless the exchange rate is firmly fixed through a currencyboard, unification with another currency, or the adoption of another currency as thedomestic currency (dollarization).Flexible exchange rates among the major industrial country currencies seem likely toremain a key feature of the system. The launch of the euro in January 1999 marked a

new phase in the evolution of the system, but the European Central Bank has a clearmandate to focus monetary policy on the domestic objective of price stability ratherthan on the exchange rate. Many medium-sized industrial countries, and developingand transition economies, in an environment of increasing capital market integration,may also continue to maintain market-determined floating rates, although morecountries could may adopt harder pegs over the longer term. Thus, prospects arethat: exchange rates among the euro, the yen, and the dollar are likely to continue toexhibit volatility, and schemes to reduce volatility are neither likely to be adopted,nor to be desirable as they prevent monetary policy from being devoted consistentlyto domestic stabilization objectives;

several of the transition countries of central and eastern Europe, especially thosepreparing for membership in the European Union, are likely to seek to establish overtime the policy disciplines and institutional structures required to make possible theeventual adoption of the euro.The approach taken by the IMF continues to be to advise member countries on theimplications of adopting different exchange rate regimes, to consider the choice ofregime to be a matter for each country to decide and to provide policy advice that isconsistent with the maintenance of the chosen regime (Box 3).

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Q. 6 Discuss the various International product and pricing decisions. (10 marks)

Sol.

Production decisions

In decisions on producing or providing products and services in the internationalmarket it is essential that the production of the product or service is well planned andcoordinated, both within and with other functional area of the firm, particularlymarketing. For example, in horticulture, it is essential that any supplier or any of his"out grower" (sub-contractor) can supply what he says he can. This is especially vitalwhen contracts for supply are finalized, as failure to supply could incur largepenalties. The main elements to consider are the production process itself,

specifications, culture, the physical product, packaging, labelling, branding, warrantyand service.

International Pricing In New Open-Economy ModelsRecent developments in open-economy macroeconomics have progressed under theparadigm of nominal price rigidities, where monetary disturbances are the mainsource of fluctuations. Following developments in closed-economy models, new open-economy models have combined price rigidities and market imperfections in a fullymicro founded inter-temporal general equilibrium setup. This framework has beenused extensively to study the properties of the international transmission of shocks,as well as the welfare implications of alternative monetary and exchange ratepolicies.Imperfect competition is a key feature of the new open-economy framework. Becauseagents have some degree of monopoly power instead of being price takers, this

framework allows the explicit analysis of pricing decisions. The two polar cases forpricing decisions are producer-currency pricing and local-currency pricing. The firstcase is the traditional approach, which assumes that prices are preset in the currencyof the seller. In this case, prices of imported goods change proportionally withunexpected changes in the nominal exchange rate, and the law of one price alwaysholds. In contrast, under the assumption of local-currency pricing, prices are presetin the buyers currency. Here, unexpected movements in the nominal exchange ratedo not affect the price of imported goods and lead to short-run deviations from thelaw of one price.Empirical evidence using disaggregated data suggests that international markets fortradable goods remain highly segmented and that deviations in the law of one price

are large, persistent, and highly correlated with movements in the nominal exchangerate, even for highly tradable goods. Moreover, there is strong evidence that the largeand persistent movements that characterize the behaviour of real exchange rates atthe aggregate level are largely accounted for by deviations in the law of one price fortradable goods.In this article I make use of a simplified version of a two-country model where thetwo markets are segmented, allowing firms to price discriminate across countries, andwhere prices are preset in the consumers currency. This model generates movements

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in the real exchange rate in response to unexpected monetary shocks, which are aresult of the failure of the law of one price for tradable goods. I then compare thismodel to a version in which prices are preset in the producers currency and examinethe implications of these two alternative price-setting regimes for several key issues.The price-setting regime determines the currency of denomination of imported goods

and the extent to which changes in exchange rates affect the relative price ofimported to domestic goods and the international allocation of goods in the short run.That is, different pricing regimes imply different roles for the exchange rate in theinternational transmission of monetary disturbances. As we shall see, this assumptionhas very striking implications for several important questions, namely real exchangerate variability, the linkage between macroeconomic volatility and internationaltrade, and the welfare effects of alternative exchange rate regimes, among others.While generating deviations from the law of one price that are absent from modelsassuming producer-currency pricing, the assumption of local-currency pricing stillleaves important features of the data unexplained. The key role of this assumption inthe properties of open-economy models suggests that it is necessary to keep exploringthe implications of alternative pricing structures in open-economy models.In Section 1, I review the empirical evidence on the behaviour of real exchange ratesand on international market segmentation and pricing. In Section 2, I present themodel with local-currency pricing and explore the main implications of this pricingassumption. The final section concludes.1 Some Evidence on Real Exchange RatesI first review some empirical evidence on the behaviour of real exchange rates usingaggregate data. I then turn to a review of the evidence on the sources of movementsin real exchange rates.The real exchange rate between two countries represents the relative cost of acommon reference basket of goods. For two countries, say the United States andJapan, the real exchange rate is given by

where P^sub US^ and P^sub JP^ represent the American and Japanese price levels(measured in terms of dollars and yen, respectively) and where e denotes the nominalexchange rate (defined as the dollar price of one yen).The theory of purchasing power parity (PPP) predicts that real exchange rates shouldequal one, or at least show a strong tendency to quickly return to one when theydiffer from this value. The fundamental building block of PPP is the law of one price:due to arbitrage in goods markets, and absent barriers to trade, similar productsshould sell in different countries for the same price (when converted in the samecurrency). Large international price differentials would be only temporary, as profit-maximizing traders would quickly drive international goods prices back in line.Therefore, if arbitrage in goods markets ensures that the law of one price holds for a

sufficiently broad range of individual goods, then aggregate price levels (whenexpressed in a common currency) should be highly correlated across countries.Because aggregate prices are reported as indices rather than levels, most empiricalwork has tested the weaker hypothesis of relative PPP, which requires only that thereal exchange rate be stable over time. Figure 1 show the log changes in the CPI-based dollar-yen real and nominal exchange rates and the relative price level. In this

figure, which is typical for countries with floating exchange rates andmoderate

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inflation, it clearly stands out that short-run deviations from PPP are large andvolatile.(Delete) In the short run, movements in the real exchange rate mimic thosein the nominal exchange rate, with no offsetting movements in the relative pricelevel. Not surprisingly, early empirical work based on simple tests of short-run PPPproduced strong rejections of this hypothesis for moderate inflation countries.

However; these studies did not allow for any dynamics of adjustment to PPP andtherefore did not address the validity of PPP as a medium- or long-run proposition.The conventional explanation for the failure of short-run PPP is the presence ofnominal price rigidities. If the short-term volatility of nominal exchange rates weredue mostly to monetary and financial disturbances, then nominal price stickinesswould translate these disturbances into short-run fluctuations in the real exchangerate. If this were true, however, we should observe a substantial convergence to PPPin one to two years, as the adjustment of prices and wages takes place. Purchasingpower parity, therefore, would be re-established in the medium to long run.