Reading: Lesson 1 - The Importance of International Business

5.1.A - The Importance of International Business

1. THE SCOPE OF INTERNATIONAL BUSINESS

1. International business is not new. People around the world have been trading since the beginning of history. Phoenician and Greek merchants were sailing the seas to sell and buy products in Africa and Europe long before recorded history. In 1600, the British East India Company was formed in order to establish branches and trade with countries in Asia. As Europeans discovered sea routes around the world, trade flourished among the nations of Europe and countries such as China, India, and Indonesia. American colonial traders began operating in a similar way.
   
2. Similarly, people throughout the world were investing in businesses abroad. An early example of successful American investment abroad was a factory built in Scotland by the Singer Sewing Machine Company in 1868. By 1880, Singer had become a worldwide organization with several sales offices and factories in other countries. During the eighteenth and nineteenth centuries, a great economic expansion occurred in the United States. Largely financed by foreign money, businesses laid railway lines, opened mines to extract coal and iron ore, and built factories.
   
3. International business typically means business activities that occur between two or more countries. Every country has its own laws and rules, its own currency, and its own traditions of doing business. When a restaurant manager in New Jersey buys lobsters from Maine, everyone understands the rules of business, because they are similar from state to state. When the restaurant manager buys salmon caught by Chilean fishermen, the rules of business are not as clear, because they differ from country to country.
   
4. Only since the end of World War II in 1945 has international business become a dominant aspect of economic life. Foreign trade has flourished. Companies have grown rapidly and operate on a global scale. Countries have become highly interdependent, so that events in one place have an impact in another place. Almost every business and individual is affected directly or indirectly by international business. As you saw in the opening vignette, although Jake was not directly involved in international business, his business was being hurt by the availability of cheaper products from Thailand.
   
5. Look around and you will see names you are sure are foreign: Honda cars, Sony televisions, Benetton clothes, and Chanel perfume. But what about names such as Clearasil, Dannon, and LensCrafters? They are the brand names of products of foreign companies. See the Figure below for more information about these brands. Also, think of familiar American companies such as McDonald’s, General Motors, IBM, Coca-Cola, and Apple. A growing portion of their total sales occurs in foreign countries. 
   

   
   

6. Business activities are not confined by country borders. Foreigners buy American products (computers, wheat, airplanes) and services (banking, insurance, data processing) just as Americans buy foreign products (petroleum, cars, clothes) and services (vacations, shipping, construction). The United States trades with many countries. A list of the major U.S. trading partners appears in the Figure below. American firms make many products in factories in foreign countries just as foreign companies make products in the United States. In 2013, world trade in goods exceeded $18.8 trillion. 
   

   
   

7. Most of the world’s trade takes place among developed countries. This group includes Japan and countries in North America and Western Europe. Over the past 35 years, countries in Asia have emerged as big trading nations. China, in particular, has become a trade powerhouse. The Figure below lists the leading exporters and importers of goods and services. Trade patterns have shifted from goods to services. Although goods remain dominant, service industries now represent one-fifth of international trade. When service industries emerged as an important segment of the American economy, more and more trade and investments occurred in businesses such as tourism, banking, accounting, advertising, and computer services. 
   

   
   

   
   

8. As with trade, most investments are made within and by the world’s most industrialized economies. Annual foreign investment by the countries with the top 20 economies exceeded $942 billion. In recent years, though, China has become both a major recipient of foreign investment, receiving over $124 billion, and a major direct foreign investor in other countries at $101 billion. Foreign investment occurs when firms of one country build new plants and facilities or buy existing businesses in another country. An example of such investment would be the investment in AMC Theatres in the United States by the Chinese company Wanda Group in 2012.
   

9. International trade and investment are a big and growing part of the American economy. In a recent year, America sold over $2.35 trillion of its goods and services to foreign customers. Almost 20 percent of all jobs depend on foreign trade, and over 5.6 million workers are employed by foreign companies operating in the United States. Foreign firms have invested nearly $2.8 trillion in the United States. Total American investment abroad exceeds $4 trillion over 20 years. The Figure below shows the top countries that have invested in the United States and the reciprocal investment of American companies to those counties.
   

   
   

2. REASONS FOR GROWTH IN INTERNATIONAL BUSINESS

1. Why would McDonald’s want to open a restaurant in Beijing, or Nokia sell mobile telephones in the United States, or Volkswagen build its Beetles in Mexico? For that matter, why would Macy’s buy the jeans it sells from a garment maker in Hong Kong? Firms enter international business for many good reasons.
   
2. The main reason is profit. Businesses may be able to earn more profit from selling abroad or may be able to charge higher prices abroad than at home, where competition could be more intense. When the cost of making goods is lower in foreign countries than at home, it becomes cost effective for companies to buy goods made abroad or even set up their own factories abroad. The potential for sales abroad, when combined with the size of the domestic market, increases the overall size of the market. Using mass-production techniques, production costs should drop and profits should rise.
   
3. In many cases, a company goes international in reaction to what other companies are doing or because of changes in the domestic market. If some firms are making large profits by selling abroad, other companies may be encouraged to do the same. When a large foreign market opens up, as in China in recent years, an American company may lose the market to firms from other countries if it does not act quickly. Similarly, sales at home may be small, stagnant, or declining, whereas opportunities to sell abroad may be abundant. A company may have overproduced, and the only way to possibly dispose of its surplus goods profitably is to sell them abroad. It could also be that a company is physically close to foreign customers and markets. For example, Argentine firms can sell easily to Brazilian firms because they are neighbors.
   
4. Several factors help firms engage in international business. One key factor is treaties on trade and investment signed by different countries. The World Trade Organization (WTO) is an international organization that creates and enforces the rules governing trade among countries. Trade agreements negotiated under the authority of the WTO have led to huge cuts in taxes on foreign goods. These cuts have boosted exports and imports among the 161 member countries. Development of trading blocs has also stimulated global trade and investment. A trading bloc is a group of two or more countries that agree to remove all restrictions between them on the sales of goods and services, while imposing barriers on trade with and investment from countries that are not part of the bloc.
   
5. There are many forms of trading blocs. The best example of an advanced form of trading bloc is the European Union (EU). The EU currently has 28 members, as shown in the Figure below. Since it was formed in 1957 as the European Economic Community, the EU has gone beyond free trade among its members. It is trying to create a “United States of Europe,” where there will also be free movement of capital and labor and where common economic and monetary policies will be followed. On January 1, 1999, 11 EU members took a major step toward integrating their economies by merging their national currencies into a single new currency called the euro. With a single currency, international firms can look at these European countries as a single market and do not have to worry about exchange rate changes. 
   

   
   

6. In 1989, the United States signed a free-trade agreement with Canada. In 1992, Canada and the United States signed a similar agreement with Mexico, called the North American Free Trade Agreement (NAFTA), which created the world’s largest trading bloc by removing import taxes and other barriers to trade among the three nations. Many American firms have relocated to Mexico to take advantage of the lower costs of production in that country. Unlike the EU, under NAFTA there is no move yet to allow unrestricted movement of people among the three countries or to integrate the three economies with common monetary or economic policies.
   
7. International business is also facilitated by two major international institutions—the International Monetary Fund (IMF) and the World Bank. The IMF’s main purpose is to help countries that are facing serious financial difficulties in paying for their imports or repaying loans. The World Bank provides low-cost, long-term loans to less-developed countries to develop basic industries and facilities, such as roads and electric power plants.
   
8. Another factor that has helped international business is the tremendous advances in communication and transportation. Telephone, fax, and the Internet have made it cheaper and quicker to obtain information from around the world and conduct business around the clock. The Internet and television broadcasts enable firms to advertise their products worldwide and create a global consumer culture. Faster and cheaper transportation has meant that firms can easily ship goods long distances. For example, thanks to air transport, tulips grown in the Netherlands are shipped daily to florists in New York City.
   
9. Since the fall of the Iron Curtain in Europe and the economic reform in China in the early 1990s, the world has seen a move toward free-enterprise practices. Many governments have reduced their control over the economy. Several types of businesses that were strictly regulated by the government, such as telecommunications and airlines, have been opened up to competition. In many foreign countries, business enterprises owned by the government have been sold to private owners—both domestic and foreign. All these changes have opened up new investment and trading opportunities for foreign firms.