International Business Transactions
Competition in Trade Terms:
Gross Domestic Product/GDP: The sum total of all goods and services produced in a country.
Participation in a Global Market as a Country
i. You want to place yourself in a position at an advantage. You want to produce the things that will give you as a country a comparative advantage.
ii. Comparative Advantage: In economics, the principle of comparative advantage explains how trade is beneficial for all parties involved (countries, regions, individuals and so on), as long as they produce goods with different relative costs.
1. Decide what to produce
2. Decide what to import
iii. How do you decide this?
1. Labor is the most important variable.
a. Labor Theory of Value: Labor is the one variable that makes a difference in the value of a good. The labor that goes into a product is what gives the product value. The higher the cost of labor, the higher the cost of the product because the labor costs are passed on to the consumer.
b. In one country it is easier to equalize labor costs from state to state, thus it would be hard for one state to beat the pants off of a another state. This is because people can easily cross state lines.
c. Keep in mind that labor is not homogenous. You cannot substitute one form of labor for another very easily. It takes a lot of work to make a construction worker into a computer programmer.
d. Labor is therefore segregated by industry.
2. Labor is not the only variable in determining value to develop a comparative advantage (land, capital, labor, etc.)
a. Because it is more difficult to equalize labor costs from country to country, other variables must be taken into account in order to develop a comparative advantage.
b. Comparative Advantage looks at all that is involved in producing a good (labor, capital, land, etc.)
c. Ex. What does it take for a country to produce one meter of a piece of cloth?
i. As opposed to what it takes for the UK to produce the same thing?
ii. If I think the UK is going to deploy fewer inputs to produce the same thing, it would be silly for me as a country to produce cloth.
d. A country will export things that will cost them less giving them a comparative advantage, and import the things that will cost them more in which they do not have a comparative advantage.
i. American consumers will buy foreign goods if they are cheaper than American produced goods that are more expensive to them.
ii. Countries can maximize by producing goods in which they have a comparative advantage. No country is self sufficient because it would be stupid to produce something that is produced much more cheaply somewhere else.
Benefits of Free Trade
Free Trade: You really cannot have “free trade” because the word “free” suggests no regulation, but in reality trade is highly regulated. The goal of free trade is to reduce the barriers of trade making it easier for people to trade together across borders.
i. Ex. If I can sell asbestos products in my country I cannot tell you that you can’t. However, if I do not sell asbestos products in my country, I can regulate and disallow you from selling asbestos products in my country too without violating the principles of free trade. You must look at the purpose of the regulation.
ii. Free trade is a source of global prosperity, because without trade we will all be in trouble. Consumers would have no choices without trade. You can get things that you cannot produce and export things to other countries that they cannot produce.
1. Benefits to the Consumer:
a. Consumers get a larger selection of more affordable choices.
b. Free trade also destroys monopolies and monopolistic pricing of goods. It is very difficult for a domestic producer, or any producer to create a monopoly in a free trade regime because there are so many producers competing in the market. Domestic producers are not the only ones competing with a single foreign producer, there are many other foreign producers also competing.
c. Forces domestic producers to produce higher quality products, because if they don’t then the foreign producers will kick them out of the market place.
2. Benefits to the Producer
a. You are selling not only to the domestic market but also in external foreign markets. Producers want more markets to sell their goods, allowing them to make more money, expand production, which leads to more investment in the local economy (expansion of operations = more jobs, etc.)
3. Benefits to the Government
a. It is able to collect more taxes. Whenever there is trade, the government can collect more taxes. The more taxes collected, the more government spending (such as publicly beneficial government programs).
4. Drawbacks of Free Trade
a. Foreign producers can force domestic producers compete with their lower prices such as through:
i. Increased quality
ii. Lowering production costs
iii. Saying “buy American goods”
b. If the domestic producers cannot compete, foreign competitors can bankrupt local companies and economies.
i. Reducing employment
ii. Reducing government revenue
iii. Creates other social problems (crime, broken families, etc.)
c. Foreign competition have no loyalties, except for cash
d. Unless there are strong regulations on the environment, companies are polluters. They can destroy water, air quality, etc.
e. If there is not good consumer protection, companies will produce substandard goods. The more producers in the market, the more goods there are to be regulated.
iii. Counter Argument Opposing Free Trade: Free Trade can be contrasted with protectionism, which is the economic policy of restricting trade between nations. Trade may be restricted by high tariffs on imported or exported goods, restrictive quotas, a variety of restrictive government regulations designed to discourage imports, and anti-dumping laws designed to protect domestic industries from foreign take-over or competition.
iv. Most Common Methods of Trade Restriction
1. Tariff: A tax that is levied upon products which come from outside the country. On
ii. You may be dealing in different currencies
iii. There are language barriers
iv. Different legal backgrounds
v. Different governments
vi. Questions of applicable law in a dispute
vii. Questions in enforcement if there is a breach of contract
Solutions: There have been attempts to standardize these issues through international conventions.
i. Sales Agreement: The basic sales agreement between Seller in Country A and Buyer in Country B
ii. Letter of Credit Agreement: The agreement between the buyer and the buyer’s bank for the issuance of a letter of credit on the buyer’s behalf
1. The L/C is taken out by the buyer in a local bank in the buyers country. The letter of credit is then transmitted to a bank in the sellers country. The beneficiary of the L/C is the seller of the goods. Both the buyer and the seller need not ever see the letter of credit. The transaction is essentially between the banks.
iii. Letter of Credit: An instrument that makes international sales agreements possible. It is a document that is obtained by the buyer of the goods as an assurance to the seller that the seller will be paid by a bank of good reputation. Meaning that the seller will be paid by a bank that can be sued if there is a problem.
1. The letter of credit itself, whereby Buyer’s Bank commits itself to pay Seller for the goods upon certain conditions; this letter is probably forwarded through Seller’s Bank which will act as the agent of Buyer’s bank.
2. Sometimes called a confirmed letter of credit or an irrevocable letter of credit. An irrevocable L/C means that the letter of credit is already paid for by the buyer.1
iv. Bill of Lading: The seller’s contract with a Carrier for shipping the goods to the buyer. An itemization of all the goods that have been shipped. Once the buyer has seen this, he then authorizes the bank to release the letter of credit to the seller to fulfill the contract.
v. Insurance: The seller’s contract with an Insurer for insurance of the cargo
vi. Loan Agreement: Perhaps a loan agreement between Buyer and Buyer’s bank to provide Buyer with the funds to pay for the goods, which likely gives a security interest in the goods to the bank
vii. Note: Buyers responsibility to make sure the goods will be acceptable in his country, because the seller’s responsibility ends once the ship sails. However, even after the ship sails the seller must be kind to the buyer.
