INTERNATIONAL FINANCE

BBA-403
Lectures 4
October 7, 2020
 Factors Affecting International Trade Flows
International trade can significantly affect a country’s economy, and it is important to identify and
monitor the factors that influence it. The most important factors are:

• Cost of labor,

• Inflation,

• National income,

• Credit conditions,

• Government policies, and

• Exchange rates.
Cost of Labor
• The cost of labor varies between countries. Many Chinese workers earn wages of less than $300 per month; not
surprisingly Chinese firms commonly produced products that were labor intensive—at a much lower cost than most
countries in Europe and North America.
• Firms in countries where labor costs are low typically have a cost advantage when competing globally, especially in
labor-intensive industries.
Inflation
• If a country’s inflation rate increases relative to the countries with which it trades, this could cause its exports to decrease
(if foreign customers shift to cheaper alternatives in other countries) and its imports to increase (if the local individuals
and firms shift to cheaper alternatives).
• Consequently, an increase in the country’s inflation may cause its current account to decrease.
National Income (NI)
• If a country’s income level (NI) increases by a higher percentage than those of other countries, then its current account
should decrease, other things being equal.
• As the real income level (adjusted for inflation) rises, so does consumption of goods. A percentage of that increase in
consumption will most likely reflect an increased demand for foreign goods.
Credit Conditions
• Credit conditions tend to tighten when economic conditions weaken because corporations have reduced ability to repay
debt.
• Banks are less willing to provide financing to MNCs, which can reduce corporate spending and further weaken the
economy. As MNCs reduce their spending, they also reduce their demand for imported supplies. The result is a decline in
international trade flows.
. GovernmentPolicies
• Government policies can have a major influence on which firms within an industry attain the most market share worldwide.
These policies affect the legislating country’s unemployment level, income level, and economic growth.
• Government wants to increase its exports because more exports lead to more production and income, and may also create jobs.
Moreover, a country’s government generally prefers that its citizens and firms purchase products and services locally (rather
import them) because doing so creates local jobs.

• There are several types of policies used to improve the balance of trade and thereby to create jobs within a country:
oRestrictions on Imports through tariffs & quotas (Imports reduce)
oSubsidies for Exporters (Exports increase and imports increase)
oRestrictions on Piracy; (Lack of restrictions decrease demand for imports)
oEnvironmental Restrictions: local firms experience higher costs of production (Exports decrease; imports increase)
oLabor Laws: higher expenses for labor (Exports decrease; imports increase)
oBusiness Laws: e.g. Bribery (Exports decrease; imports increase)
oTax Breaks (Exports increase and imports increase)
oCountry Trade Requirements for foreign firms
oGovernment Ownership or Subsidies
oCountry Security Laws
oPolicies to Punish Country Governments
 Example
Assume that a large number of agriculture firms in the USA have lost business recently because local
consumers have begun buying vegetables imported from the country of Vegambia at much lower prices.

• Having laid off many employees as a result, these firms decide to lobby their political representatives.
The agriculture firms argue that:
• vegetables from Vegambia are unfairly priced because Vegambia’s government gives tax breaks to
the firms that grow the vegetables,
• there is speculation that the vegetables imported from Vegambia have caused illness among some
consumers, and
• Vegambia allows its children to work at an earlier age than the age allowed in the United States.
• In response to this lobbying, the U.S. government decides to impose restrictions on imports. Vegambia’s
vegetable exports to the United States consequently decline, and its unemployment rate rises.
• Vegambia’s government decides that it can correct its unemployment rate by improving its balance of
trade deficit.
Example Continued…
Some of its firms specialize in manufacturing toys, but sales have been weak recently because
many local citizens purchase toys imported from the United States. The government of
Vegambia determines that:

• the U.S. toy manufacturers have an unfair advantage because they pay low taxes (as a proportion
of their income) to the U.S. government,
• the toys produced in the United States present a health risk to local children because reportedly a
few children have hurt themselves while playing with these toys, and
• the U.S. government has failed to intervene in some foreign countries to prevent the production of
illegal drugs that flow into Vegambia, so Vegambia should reduce U.S. imports as a form of
protest.

Therefore, the government of Vegambia prohibits the importing of toys from the United States.
 Exchange Rates
Each country’s currency is valued in terms of other currencies through the use of
exchange rates. Currencies can be exchanged to facilitate international transactions.

• The value of most currencies fluctuates over time because of market and
government forces. If a country’s currency begins to rise in value against other
currencies then its current account balance should decrease, other things being
equal.

• As the currency strengthens, goods exported by that country will become more
expensive to the importing countries and thus the demand for such goods will
decrease.
Example
Malibu Co. produces tennis rackets in the United States and sells some of them to European
countries. Its standard racket is priced at $140, and it competes with the Accel racket in both the
U.S. and the Eurozone market.

• When the euro was valued at $1.60, eurozone consumers paid about 87 euros for Malibu’s racket
(computed as $140/$1.60 = 87.50 euros). Because this price to eurozone consumers was lower than the
Accel racket price of 100 euros per racket, Malibu sold 7,000 rackets in the eurozone at that time.

• When the euro’s value fell to $1.20, however, eurozone consumers had to pay about 117 euros for
Malibu’s standard tennis racket (i.e., $140/$1.20), which is more than the 100 euros for an Accel racket.

• Hence Malibu sold only 2,000 rackets to eurozone consumers in this month. As those consumers
reduced their demand for Malibu rackets, they increased their demand for tennis rackets produced by
Accel
 International Capital Flows

• One of the most important types of capital flows is FDI. Firms commonly attempt to
engage in FDI so that they can reach additional consumers or utilize low-cost labor.

• Europe as a whole attracts more than 50 per cent of all FDI by U.S.-based MNCs.
Another 30 per cent of that FDI is in Latin America and Canada, with about 15 per
cent more in the Asia and Pacific region. The United Kingdom and Canada enjoy the
most FDI by U.S.-based MNCs.
https://tribune.com.pk/story/2260461/pakistans-fdi-falls-to-11-month-low-level
 Factors Affecting FDI
• Many countries lowered their restrictions on FDI during the 1990s, which resulted
in more FDI in those countries. Many U.S.-based MNCs (including Bausch &
Lomb, Colgate-Palmolive, and General Electric) have penetrated less developed
countries such as Argentina, Chile, China, Hungary, India, and Mexico.

• Several national governments have engaged in privatization, which is the selling of

• Countries that impose relatively low tax rates on corporate earnings are more likely to
attract FDI. When assessing the feasibility of FDI, firms estimate the after-tax cash
flows that they expect to earn.

• Firms typically prefer to pursue FDI in countries where the local currency is expected to
strengthen against their own. Under these conditions, they can invest funds to establish
their operations in a country at a time when that country’s currency is relatively cheap
(weak).
 Agencies That Facilitate International Flows
International Monetary Fund
• Formed in July 1944 to develop a structured international monetary system. The major objectives of the IMF, as
set by its charter, are to:
(1) promote cooperation among countries on international monetary issues,
(2) promote stability in exchange rates,
(3) provide temporary funds to member countries attempting to correct imbalances of international payments,
(4) promote free mobility of capital funds across countries, and
(5) promote free trade. It is clear from these objectives that the IMF’s goals encourage the increased
internationalization of business
World Bank
• The International Bank for Reconstruction and Development (IBRD), also referred to as the World Bank, was
established in 1944. Its primary objective is to make loans to countries in order to reduce poverty and enhance
economic development.
• The World Bank has been successful at reducing extreme poverty levels, increasing education, preventing the
spread of deadly diseases, and improving environmental conditions.
• Its main source of funds is the sale of bonds and other debt instruments to private investors and governments.
 Agencies That Facilitate International Flows
World Trade Organization
• Was created as a result of the Uruguay round of trade negotiations that led to the GATT accord in 1993.
• This organization was established to provide a forum for multilateral trade negotiations and to settle trade
disputes related to the GATT.
International Finance Corporation
• In 1956 the International Finance Corporation (IFC) was established to promote private enterprise within
countries.
• Composed of a number of member nations, the IFC works to promote economic development through the private
rather than the government sector.
• It not only provides loans to corporations but also purchases stock, thereby becoming part owner in some cases in
addition to a creditor
International Development Association
• The International Development Association (IDA) was created in 1960 with country development objectives
similar to those of the World Bank. However, its loan policy is more appropriate for less prosperous nations.
• The IDA extends loans at low interest rates to poor nations that cannot qualify for loans from the World Bank.
 Agencies That Facilitate International Flows
Bank for International Settlements
• It attempts to facilitate cooperation among countries with regard to international transactions.
• It serves central banks of countries in their pursuit of financial stability. The BIS is sometimes referred to as
the “central banks’ central bank” or the “lender of last resort.” It played an important role in supporting some
of the less developed countries during international debt crises
OECD
• The Organisation for Economic Co-operation and Development (OECD) facilitates governance in
governments and corporations of countries with market economics.
• It has 34 member countries as well as relationships with numerous other countries. The OECD promotes
international country relationships that lead to globalization
Regional Development Agencies
• Inter-American Development Bank (focusing on the needs of Latin America),
• Asian Development Bank (established to enhance social and economic development in Asia)
• African Development Bank (focusing on development in African countries)
• European Bank for Reconstruction and Development (o help Eastern European countries adjust from
communism to capitalism)
 Case Studies Questions - Pages 60-61

1. How could a higher level of inflation in Thailand affect Blades (assume U.S. inflation
remains constant)?
2. How could competition from firms in Thailand and from U.S. firms conducting
business in Thailand affect Blades?
3. How could a decreasing level of national income in Thailand affect Blades?
4. How could a continued depreciation of the Thai baht affect Blades? How would it
affect Blades relative to U.S. exporters invoicing their roller blades in U.S. dollars?
5. If Blades increases its business in Thailand and experiences serious financial
problems, are there any international agencies that the company could approach for
loans or other financial assistance?
TASKS

• Read Chapter 2: International Flow of Funds (Madura)

• Review Case Study for Blades and answer the Questions (Pages 60-61)