Search This Blog

Tuesday, June 16, 2009

What are the basic limitations of World Trade Organisation?

Read the following case and answer the questions given at the end.


WRONG TRADE ORGANISATION


One of the banners one saw during the demonstration at Seattle proclaimed the WTO was not the World Trade Organisation but the Wrong Trade Organisation.

It was the Wrong Trade Organisation because it involved itself with trade which (as the protestors saw it) spoilt the environment and promoted unacceptable working conditions for labourers in the poor countries. In the face of it, the charge is clearly not acceptable, but then, do the demonstrations have a point at all?

In the eyes of the demonstrators, the WTO would not have been the Wrong Trade Organisation if it could ensure that more trade did not automatically mean greater damage to the global environment. On this, one can have no quarrel with the Seattle demonstrators at all.

If we look at labour, everyone will agree with the premise that the most important objective of economic development is to improve the living standards of the people.

Since the business of a higher trade exchange is to derive larger profits from such exchange which can be used to hasten economic development, it can be argued that more trade should ultimately lead to better living standards. This includes labour and living standards, the inference being that more trade should lead to better living standards for labour.

The Seattle demonstrators said that this is not always the case and that in large parts of the developing world, the production of goods that ultimately generated higher trade figures rested on unsatisfactory working conditions.

Their point was that the WTO was not doing anything to ensure that such production did not enter the stream of globally traded items.

Both the charges are valid as they are, which means that concerted efforts will have to be made to look after the environment and labour aspects of higher international trade.

The question is whether it is the business of the WTO to do so. If yes, then the WTO as it is now constituted is certainly the Wrong Trade Organisation. If not, then the protesters are themselves wrong in trying to make the WTO responsible for something which really is not among its functions.

The question then is: Should the WTO be held responsible for the wrong done to global living standards and the environment flowing from a larger international trade exchange, or should these spheres to be responsibility of their organisations? Basically, the issue revolves around the question – should the WTO be involved in any sphere of international relations other than trade? As of now, nearly the entire developing world feels that it should not be so involved while the quest of the developed countries is to develop such extra-trade responsibilities for the WTO.

This is not an easy question to answer because the act of trading cannot be put into an airtight compartment in any social set-up. Take, for example, the issue of opening up trade in agriculture, which has become a major bone of contention among developed countries like the US, the Cairns Group, the European Union and Japan.

Tokyo has focused on the “multi-functionality” of agriculture within the Japanese economy, which really means that there are extra-economic (certainly extra-trade) dimensions of farming activity which must be taken into account before trade in farm products can be affected in any way by WTO regulations.

On its part, India has talked about “food security”, which can easily be tied up with “national security” (particularly in a poor country). This certainly cannot in any way be a responsibility of the WTO.

What therefore, is amply clear is the complex nature of the issue – if it is the business of the WTO to involve itself with the labour and environment aspects of trade. However, there is one factor of relief with respect to these two specific spheres: That there are in existence separate international forums the sole business of which is to look after the working conditions of international labour in one instance, and the world’s environment, in the other. Common sense would suggest that since the framework for international trade should be set by the standards in force on the labour and environment fronts, these spheres should be the responsibility of the already existing different forums.

In other words, since trade (being only one part of pure economic activity) cannot set the standards either in labour or the environment, the WTO should not get into these spheres of activity but should restrict itself to policing international trading activity, taking as given, the prevailing labour and environment standards.

It can, of course, be argued that since not much effective work is being done in both the labour and environment spheres by way of tightening up on standards by the different international forums currently engaged in the task – the International Labour Organisation, and so on – there is no alternative but to tighten the screw of these related aspects of trade activity within the WTO itself.
This could conceivably be the case, but if it is then why is so much being made of, say, the US signing the Worst Forms of Child Labour Convention, which is strictly an ILO document? In other words, if the WTO is the Wrong Trade Organisation, then the ILO is the Irrelevant Labour Organization, the work of which, however, has been applauded by, among others, Washington.

There are some who will argue that the entire effort to involve the WTO with the labour and environment aspects of trade and environment aspects of trade is actually a part of the larger effort by some developed countries to reduce the comparative advantage which poor countries enjoy by way of lower overall production costs, which makes their products cheaper in the world market.

If this is correct, then the point needs to be emphasized that the WTO is the right trade organisation, which is being sought to be influenced and controlled by the wrong sort people.


Questions:

1. What are the basic limitations of World Trade Organisation?
Limitations and suggested Refinements


Trade theories provide logical explanations about why nations trade with one another, but such theories are limited by their underlying assumptions. Most of the world’s trade rules are based on a traditional model that assumes that (1) trade is bilateral, (2) trade involves products originating primarily in the exporting country, (3) the exporting country has a comparative advantage, and (4) competition primarily focuses on the importing country’s market. However, today’s realities are quite different. First, trade is a multilateral process. Second, trade is often based on products assembled from components that are produced in various countries. Third, it is not easy to determine a country’s comparative advantage, as evidenced by the countries that often






Export and import the same product. Finally, competition usually extends beyond the importing country to include the exporting country and third countries.
In all fairness, virtually all theories require assumptions in order to provide a focus for investigation while holding extraneous variables constant. But controlling the effect of extraneous variables acts to limit a theory’s practicality and generalization.
One limitation of classical trade theories is that the factors of production are assumed to remain constant for each country because of the assumed immobility of such resources between countries. This assumption is especially true in the case of land, since physical transfer and ownership of land can only be accomplished by war or purchase e.g., the U.S. seizure of California from Mexico and the U.S. purchase of Alaska from Russia. At present, however, such means to gain land are less and less likely. As a matter of fact, many countries have laws that prohibit foreigners from owning real estate. Thus, Japan and many other countries remain land-poor.
A significant difference exists in the degree of mobility between land and capital. In spite of the restrictions on the movement of capital imposed by most governments, it is possible for a country to attract foreign capital for investment or for a country to borrow money from foreign banks or international development agencies.



Not surprisingly, U.S. banks, as financial institutions in a capital-rich country, provide huge loans to Latin American countries. Yet at the same time, a favorable U.S. business climate makes it possible for the United States to attract capital from abroad to help finance its enormous federal deficits. Therefore, capital is far from being immobile.

Labor as a factor is relatively immobile. Immigration laws in most countries severely limit the freedom of movement of labor between countries. In China, people (i.e., labor) are not even able to select residence in a city of their choice. Still, labor can and does move across borders. Western European nations allow their citizens to pass across borders rather freely. The United States has a farm program that allows Mexican workers to work in the United States temporarily. For Asian nations, most are so well-endowed with cheap and abundant labor that such countries as South Korea and Thailand send laborers to work in Saudi Arabia. China, likewise, would like to export its labor because it is the most well-endowed nation in the world in terms of this resource. In the mid—19th century many Chinese peasants were brought to the United States for railroad building.

While immigration laws often restrict labor movement across countries, business laws however tend to welcome capital movement to utilize labor in a foreign country. When wages in South Korea jumped, Goldstar Co. minimized the labor problem by importing goods from its overseas facilities back into South Korea. It can be said that, in the production of tradable goods, unskilled labor markets in the developed countries have been effectively joined with international markets. As in the case of apparel assembly and footwear which do not lend themselves as yet to technology-intensive methods. A large share of output already has been transferred to poor countries. Even in Thailand where labor was once plentiful and cheap but where labor cost has moved up, some Thai apparel firms are transferring parts of their production operations to Cambodia and Vietnam. Likewise, Taiwanese shoe companies are establishing new operations on the mainland.

Because workers cannot easily emigrate to another country possessing better wages and benefits, wages have not been equalized across countries. Conceivably, computer workstations and communications technology could lessen this problem by allowing a portion of the work force to work for any company in any part of the world. As mentioned by Andrew Grove, Intel Corp.’s chief executive officer, “Capital and work-your work and your counterpart’s work-can go anywhere on earth and do a job. . . .If the world operates as one big market, every employee will compete with every person anywhere in the world who is capable of doing the same job.” Theoretically, if developments continue along these lines, a worldwide labor market is possible.
In the 1970s and 1980s, workers in the Western world learned a painful lesson: manufacturing could be moved virtually anywhere. History may repeat itself again as it is becoming easier for firms to shifrt knowledge-based labor as well. This development can be attributed to the worldwide shift to market economies, improved education, and decades of overseas training by multinationals. As a result, a global work force is emerging, and it is capable of doing the kind of work once reserved for white-collar workers in the West. Advances in telecommunications are makings these workers. More accessible than ever. In electronics, Taipei, Edinburgh, Singapore, and Malaysia, although far away from the end-user and technological breakthroughs, have emerged as global product-development centers. Therefore, conventional notions of comparative advantage are rapidly changing.

Production factors are now considered more mobile than previously assumed, but their mobility is still considerably restricted. As a result, production costs and product prices are never completely equalized across countries. The small amount of mobility that does exist serves to narrow the price/cost differentials. In theory, as a country exports its abundant factor, that factor becomes more scarce at home and its price rises. In contrast, as a country imports a scarce factor, it increases the abundance of that factor and its price declines. Therefore, a nation is usually interested in attracting what it lacks, and this practice will affect the distribution of production factors.

Since a country’s factors of production can change owing to factor mobility, it is reasonable to expect a shift in the kind of goods a country imports and exports. Japan, once a capital-poor country, has grown to become a major lender/supplier of money for international trade. Its trade pattern seems to reflect this change.

Immobility is not the only item of relevance when considering the factors of production. Another item that is very significant involves the level of quality of the production factors. It is important to understand that the quality of each factor should not be assumed to be homogeneous worldwide. Some countries have relatively better-trained personnel, better equipment, and better-quality land and climate.
Although a country should normally export products that utilize its abundant factors as the product’s major input, a country can substitute one production factor for another to a certain extent. Cut-up chicken fryers are a good example. Japan imports chicken fryers because a scarcity of land forces it to ujse valuable land for products of relatively greater economic opportunity. Both the United States and Thailand sell cut-up chicken fryers to Japan. The two countries’ production strategies, however, differ markedly. The United States, because of its high labor costs, depends more on automation (i.e., capital) to keep production costs down. Thailand, on the other hand, has plentiful and inexpensive labor and thus produces its fryers through a labor-intensive process. Therefore, the proportion of factor inputs for a particular product is not necessarily fixed, and the identical product may be produced with alternative methods or factors.
Like Joseph Schumpeter before them, some economists argue that innovation (knowledge and its application to real business problems) counts for more than capital and labor, the traditional factors of production. Entrepreneurs, industrial research, and knowledge are what matters.

The discussion so just as critical, and demand reversal (when it occurs) may serve to explain why the explain why the empirical evidence is mixed. Tastes should not be assumed to be the same among various countries. A country may have a scarcity of certain products, and yet its citizens may have no desire for those products. Frequently, LDCs’ products may not be of sufficient quality to satisfy the tastes of industrial nations’ consumers. Yugo, for example, tried in vain to convince American consumers that is automobiles, despite their very low prices, were not a bad value or of poor quality.

In some market situations it is possible for product quality to be too high. Companies in developed countries, for example, sometimes manufacture products with too many refinements, which make the products too costly for consumers elsewhere. German machineries, for instance, have a worldwide reputation for quality. Nonetheless, many LDCs opt for less-reliable machinery products from Taiwan because Taiwan’s products are less costly. Such circumstances explain why nations with similar levels of economic development tend to trade with one another, since they have very similar tastes and incomes.

Perhaps the most serious shortcoming of classical trade theories is that they ignore the marketing aspect of trade. These theories are primarily concerned with commodities rather than with manufactured goods or value-added products. It is assumed that all suppliers have identical products with similar physical attributes and quality. This habit of assuming product homogeneity is not likely to be made among those familiar with marketing.

More often than not, products are endowed with psychological attributes. Brand-name products are often promoted as having additional value based on psychological nuance. Tobacco products of Marlboro and Winston sell well worldwide because of the images of those brands. Also, firms in two countries can produce virtually identical products in physical terms, but one product has different symbolic meaning than the other. LDCs are just as capable as the United States in making good cosmetic products, but many consumers are willing to pay significantly more for the prestige of using an American brand such as Estee Lauder. Trade analysis, therefore, is not complete without taking into consideration the reasons for product differentiation.
A further shortcoming of classical trade theories is that the trade patterns as described in the theories are in reality frequently affected by trade restrictions. The direction of the flow of trade, according to some critics of free trade, is no longer determined by a country’s natural comparative advantage. Rather a country can create a relative advantage by relying on outsourcing and other trade barriers, such as tariffs and quotas.
The U.S. trade pattern is also distorted by trade restrictions and regulations. The U.S. automobile emission control standards have effectively prevented Brazilian cars from entering the U.S. market. Thus, protectionism can alter the trade patterns as described by trade theories.

The new trade theory states that trade is based on increasing returns to scale, historical accidents, and government policies. Japan’s targeted industry strategy, for example, does not adhere to free-market principles. Therefore, a moderate degree of protection may promote domestic output and welfare. However, as pointed out by Jagdish Bhagwati, it is not easy to differentiate fair trade based on comparative advantage from what may be considered unfair trade. Are trade practices based on work habits, on infrastructure, and on differential saving behavior to be considered unfair? If so, all trade could possibly be considered unfair.





Q. 2. Why is the World Trade Organisation Called “Wrong Trade Organisation?”


Agricultural subsidies in the western world appears to be the (un)democratic right of the developed nations. The so-called 'democratic' World Trade Organisation (WTO), as The Economist prefers to address the wrong trade organisation as, sees nothing wrong in subsidising the rich and the powerful. After all, The Economist's economic survival too depends upon the advertisement revenues garnered from the corrupt -- knowing well the exposed reality of the American corporate world following the stock market scandal.
At a time when the global media continues to protect the corrupt, and when the WTO has digressed into a protectionist measure for the western agriculture, service industry and finance, it is the subsistence farmers in the majority world and their numbers swells into several billion, who have to pay the price. Many reports that we carried earlier have pointed to the direct connection between western subsidies and the mounting poverty, hunger and loss of livelihoods in the developing world. But the WTO refuses to correct itself, in fact it refuses to even accept that such huge subsidies are trade distorting in the first place!
ActionAid UK is one such charity that has relentlessly campaigned against the trade distortions. We bring you below a report from the Financial Times based on an ActionAid study. The second articles looks at the impact on Indian and developing country agriculture.
Contents:
1. ActionAid report: Agricultural subsidies lead to dumping and over-production -- by John Madeley
2. The Subsidy Conundrum: On the upswing in US and Europe -- by Devinder Sharma
3. EU six defend farm subsidies -- by Ian Black

1. ActionAid report:
Agricultural subsidies lead to dumping and over-production
JOHN MADELY / Finacial Times (UK) 24sep02
"Rich countries are paying more than $300bn a year in subsidies to their agricultural sectors, six times more than the total amount of aid to developing countries."
Government subsidies to farmers in Western countries are damaging the livelihoods of farmers in developing countries, according to a report by ActionAid. The report "Farmgate: The developmental impact of agricultural subsidies", says the subsidies have led to overproduction and dumping -- exporting at prices below the cost of production -- which is throwing small farmers in developing countries out of business.
Rich countries are paying more than $300bn a year in subsidies to their agricultural sectors, six times more than the total amount of aid to developing countries. "In a massive breach of faith, rather than complying with the spirit of [World Trade Organisation] agreements, and reducing levels of agricultural subsidies, rich countries have actually increased them," says the report.
At the same time, rich countries have put pressure on developing countries to reduce or eliminate subsidies. Rich countries are practising double standards, says the report - "protection for the rich and the free play of market forces for the poor". The farm subsidies of the EU and the US have encouraged overproduction, distorted trade and depressed prices; and made EU and US farm goods artificially cheap on world markets, resulting in the dumping of cheap, subsidised produce in poor countries.
But the subsidies have failed to prevent small UK farmers going out of business. The richest 20 per cent of UK farm holdings receive 80 per cent of the subsidies. Each tonne of UK [and EU] wheat sold on international markets is sold at 41 per cent below the cost of production, against 33 per cent in 1997.
The EU has historically ensured that returns to its wheat farmers are artificially high by using a combination of market price support - including through intervention buying and export subsidies - and direct payments. The report includes studies from Bangladesh, Indonesia, Kenya, Nigeria, Pakistan and Swaziland to show the effect of subsidies.
In 2000 there was a sudden and dramatic increase in the volume of cheap, duty-free wheat flour imported by Kenya from Egypt, undercutting local prices by up to 50 per cent and threatening the livelihoods of about 500,000 Kenyan people dependent on wheat for their income.
In 2000-01, the US and EU together supplied Egypt with almost 4m tonnes of the grain. Significant quantities of this were dumped. "There are strong suspicions," says the report, "that subsidised US and possibly EU wheat has been used to manufacture the flour in Egypt that has been sold to Kenya at cheap prices."
Cheap wheat imports to Nigeria from the US have nearly doubled since 2000 and are having a detrimental impact on the country's production of staple foods.
Subsidised wheat coming into Bangladesh as food aid is also having a negative effect on local farmers. The Washington-based International Food Policy Research Institute says the food aid helped undercut prices for local wheat producers, acting as a disincentive for them to be more self-reliant and grow their own crops.
EU subsidies to the sugar sector are also causing problems, eradicating the competitive advantage of sugar-producing developing countries. Swaziland, for example, produces sugar at less than half the cost of EU countries, and yet is unable to compete with the EU imports that increasingly dominate its market. Subsidised EU sugar exports to Swaziland have led to the loss of about 16,000 jobs in the Swazi sugar industry and 20,000 jobs indirectly linked to the industry.
ActionAid is calling for the level of agricultural support in the developed world to be reduced substantially and for a phasing out of subsidies that distort production and trade, and which lead to dumping. Negotiators are meeting at the WTO in Geneva this week to discuss how to reduce agricultural subsidies. Commonwealth finance ministers, meeting in London this week, are also likely to discuss the impact of these subsidies.

The Subsidy Conundrum:
On the Upswing in US and Europe
www.tehelka.com undated
American farmers are escaping insolvency because the US Government pumps in billions of dollars through subsidies, says Devinder Sharma.
If you are wondering as to how much subsidy an American or an European farmer receives, just hold your breath: last year, the average net income for a commercial soyabean grower in the United States was US $ 47,000 a hectare. Of which, the payment from the federal government was US $ 37,000. In England, I know of farmers who get a subsidy of one million pounds a year for not growing anything!
Against such massive government support in the rich and industrial countries, the resource-poor, lean and toiling image of an Indian farmer looks rather pale. It certainly is a depressing tale considering that more than 550 million farmers in India receive an annual subsidy of US $ 1billion, and all of it is indirect in the form of subsidised seed, fertiliser, credit, water and electricity. The amount of subsidy a western farmer gets on a cow is more than the average income of a farming family in India!
With the agricultural subsidies increasing in the two biggest farm blocks - the US and the EU - the resulting damage to the resource-poor farmers in India and, for that matter, in the other developing countries is going to be catastrophic. More so, when the Indian government continues to swear by the WTO's Agreement on Agriculture, which promises drastic reduction in agricultural subsidies being doled out in the western countries. These subsidies are, in reality, increasing.
Early this year, with the strong backing of the White House, Congress added $5.5 billion to next year's budget blueprint to cover potential emergencies. This is in addition to the US $ 22 billion plus that has already been doled out to its farming community in the past two years by the former President, Bill Clinton. In another few months, before the end of the year, the fourth instalment of federal subsidies is expected to be announced.
Interestingly, the US farm bill that George Bush often refers to, promises to end agricultural subsidies by the year 2002 - a promise that is sure to remain unfulfilled. Large farmers around the country continue to complain to Congress that Freedom to Farm is not working because their crops are selling at the same low prices their grandfathers' crops fetched 40 years ago. When lawmakers passed the act in 1996, they approved generous subsidies for the first two years in order to give farmers a cushion to prepare for their independence. But when the world market pushed prices down, farmers asked for emergency payments. And the cycle that provides more subsidies continues unabated.
As if this is not enough, George Bush promises to aggressively push to dismantle foreign trade barriers and eliminate other countries' agricultural export subsidies. And here lies the catch. True to the American character, George Bush has promised to force open the other countries' markets while protecting his own. Still, we are being told that the world is beginning to dismantle its subsidy support and that we need to open our trade barriers to make Indian agriculture competitive. And if you think that it is the American rhetoric (and not its actual actions) that is swaying popular economic thinking in India for opening up the country to US farm exports, you are mistaken. There is a strong vested Indian interest for food imports, and for obvious reasons.
And if you are wondering as to how these subsidies, for instance, impact the American farmers, let me explain. Chicago Tribune recently reported a study conducted by Farm Credit Systems, a company dealing in farm loans. According to the study, subsidies are, in a weak climate like the one that prevails today, the only barrier to insolvency. "Without federal assistance over the last three years, we would have seen large numbers of farm bankruptcies," said Doug Yoder, director of marketing for the Illinois Farm Bureau, adding that one in seven of the state's 79,000 farms is losing money this year, while many others are barely breaking even.
Take the case of Lanny Bezner, a successful family farmer in Texas. Sticking rigorously to the principle that economy of scale as the only way to survive in modern farming, he thinks that the bigger the farm, the better likelihood of turning a profit. So, he has been buying adjacent fields to expand his cropland from 700 acres to more than 8,000. In five years he has doubled his grazing land by leasing 90,000 acres of pasture. He owns a fleet of tractors and heavy farm equipment; he fills their tanks with fuel from his own gas pumps. He dries and stores his harvest in his own imposing grain elevators, which hold more than a million bushels of corn.
Talking to The New York Times, Bezner says the key to his family's prosperity is federal farm subsidies. Although he hesitates to discuss the size of those subsidies (and refused to divulge how much he makes without federal help, or what his expenses are), government documents show that in the last four years of the 1990's, he received $1.38 million in direct federal payments.
How do the American farmers' view the federal subsidies? "It's a welfare check," the Chicago Tribune report quoted Robert Johnson, 57, who farms 500 acres of corn and soybeans. "I don't like welfare and I know other people don't either--but you have to take it to survive." He said prices for his crops are too low for him to make a living. He drives a truck at night and his wife drives a school bus to make ends meet. Perhaps what Johnson does not know, and no one cared to tell him, is that when the subsidised farm commodities are exported to countries like India, it drives out farmers from agriculture leading to further marginalisation of the farming communities.
In Illinois alone, the average income of a farmer this year averaged at US $37,000 of which, US $16,000 comes from government farm subsidies. These subsidies reportedly help farmers meet their current debt liabilities. In the past two years, direct government payments to farmers in America rose 86 percent to reach US $22.7 billion, and are expected to go even higher this year. George Bush has already promised still higher federal support by way of direct payments. Incidentally, direct payments to farmers are excluded from WTO's subsidy reduction commitments.
The US Department of Agriculture expects farm income to drop this year. "Crop receipts are forecast to fall by $2 billion in 2000, reaching their lowest level since 1994," the USDA said in a report earlier this year. "Net farm income is forecast to be US $40.4 billion in 2000, a decline of $7.7 billion from the preliminary estimate of $48.1 billion for 1999." But interestingly, what the USDA refuses to acknowledge is that farm incomes are also falling in the developing countries (including India) whose trade barriers are being forced open.
Now, where will all this lead to? With the subsidy to America's miniscule farm community multiplying, and with the other industrialised countries also relentlessly jacking up financial support for agriculture, there is practically no hope for India to find a foothold in the global food market. In turn, with India phasing out or completely doing with the quantitative restrictions (QRs), the country is sure to be inundated with cheap and highly subsidised farm imports.
It has happened in the past in Zimbabwe, Burkina Faso, Mexico, Brazil, and the Philippines. It is now the turn of India to be faced with a flood of subsidised agricultural imports, some of which have already started pouring in. Unless India refuses to open up its agricultural market till such time that all farm subsidies in the developed countries are brought to zero, a disaster awaits to strike.
IAN BLACK / The Guardian 23sep02
France and six other European Union countries are insisting that the common agricultural policy, which consumes half of the EU budget, must be kept at levels agreed three years ago.
Signalling a looming battle over farm subsidies which will be critical in talks on the eastward expansion of the union, Hervé Gaymard, the French agriculture minister, and colleagues from Ireland, Spain, Portugal, Belgium, Austria and Luxembourg, insist in a letter to the Guardian that the CAP is unjustly pilloried.
Rejecting "false accusations", they defend a "European model of agriculture", and predict tough arguments ahead.
France, which receives the biggest farming subsidies, understandably champions the policy, which is the legacy of a deal between French farmers and German industry when the EEC was founded in 1957.
Britain, Germany, Sweden and the Netherlands - the "Northern Alliance" - want urgent reform of a policy which costs ?49bn (£31bn). They say the CAP cannot continue in its current form in a union of 25 or more members.
The 15 member states must quickly agree on the level of farm payments to be made to the 10 candidate states likely to be invited to join at December's Copenhagen summit.
Poland, the largest applicant, has 10 million farmers, but there is already anger over the double standards implied by proposals to pay them just a quarter of the subsidies enjoyed by current EU members.
CAP critics blame the policy for wasteful over-production, environmental damage, crises such as BSE, and contributing to hunger in the developing world. The ministers reject this and offer a robust defence of the special needs of farmers.
"Society needs sufficient numbers of contented producers with confidence in the future to ensure... economic balance and to maintain the diversity of our landscapes, which epitomise Europe.
"For us, agricultural products are more than marketable goods; they are the fruit of a love of an occupation and of the land... developed over many generations."
Last summer, the European commission proposed deep CAP subsidy cuts and higher environmental and health standards. The reformists say it does not go far enough.




Q. 3. How does WTO affect India, particularly in agriculture and in labour aspects?


Thirtythree developing countries, including six members of the G23, formed an alliance which called on the meeting to agree to a mechanism that would allow developing countries to designate products of special interest – to poorer farmers, for example – that would be exempt from WTO rules. And this could safeguard the livelihoods of millions of people, believes the G33.
The African Union formed an alliance with the African, Caribbean and Pacific group of countries and with the least developed countries – 61 WTO member countries in all. The G61 said they had come together to promote and secure their interests.
These alliances shaped the outcome of Cancun. Ivonne Juez de Baki, the trade and industry minister of Ecuador, a member of the G23, said “We have done something historic. This is the beginning of a better future for everyone.” The three groups complemented each other, but can they hold together? The US and the EU will try to divide them, although the UK’s Secretary of State for Trade and Industry Patricia Hewitt said that she “welcomes the emergence of a new, stronger voice for developing countries”. Not so President George W. Bush. Midway through the meeting the US president telephoned the leaders of Brazil, India, Colombia, Pakistan, Thailand and South Africa to ask them to leave the G23. The hint was of improved bilateral trade deals. All said no. But the pressure will intensify. The G23 countries have different interests which the US will exploit. The US may try to punish them. What might embolden the alliances is public opinion.
If there is a new factor today, which was not present in the 1960s and 70s, it’s the strength of social movements in developing countries. There is now a much higher level of awareness and more campaigning on the issues, stimulated by the effects of WTO, World Bank and IMF policies on people’s lives. When trade rules lead to Californian rice being dumped in South Korea to sell for a third of the price of local rice, and when US soya imports into Indonesia cause nearly a million farmers to go to the wall, people will back their governments when they make a stand at the WTO. Like they did in Cancun. The draft ministerial declaration antagonised developing country delegates. There was a little progress on agriculture but nothing worthwhile on helping groups like West African cotton producers, badly hit by falling world prices caused by US farm subsidies.
The alliances suggest that the WTO will in future be linked more closely to the aspirations of the developing world. But does the WTO have a future? Two of its last three ministerial meetings have failed – in Seattle in 1999 and now Cancun. The Doha meeting may only have succeeded because it was soon after 9/11 and developing countries were arm-twisted into not doing anything that might be seen as negative for the world economy.
The WTO’s decision-making processes are weak and hardly lend themselves to democratic negotiations. These procedures were a severe obstacle to progress in Cancun. The WTO sets the rules for trade, but has no rules about procedures for its meetings – about how they should be run and organised. An attempt by developing countries, in early 2002, to press for the establishment of such procedures was blocked by the EU. Wile the decision-making processes need changing, there are deeper questions about the WTO. The organisation has played no role in helping countries that rely on primary commodities trade – a serious gap as most of the world’s 49 least developed countries fall in this category.
Again the WTO has no role in regulating the traders. Almost 70% of world trade is between transnational corporations. In today’s world it is corporations that trade not countries. Through their governments, the TNCs can influence an organisation which has no power to regulate them. The WTO increasingly looks like the wrong trade organisation for the reality of international trade today. But at least it is, in theory, a democratic organisation, with its 146 countries – soon to be 148 with the addition of Cambodia and Nepal – having an equal say. Members have the power to change the rules. The new alliances have testing times ahead.

Analyse the issues and objectives on the code of conduct of transnational corporations.

Analyse the issues and objectives on the code of conduct of transnational corporations.



Issues Involved in the Negotiations

The main concern of the developed countries in the code negotiations was the establishment of a regime of minimum standards for the treatment of transnational corporations. Increased reliance on foreign investment flows was promoted consistently by the developed countries as a means to achieving efficient allocation of resources worldwide and contributing to economic growth. Some developed countries made promotion of foreign investment through the transnational corporations as a major component of there foreign economic policies. In view of the emphasis in the promotion of the transnational corporations, these countries argued for a favourable climate for foreign investments as a means of advancing and promoting economic development, and hence the need for a balanced code which established standards of fair and equitable treatment for transnational corporations, in addition to standards for their conduct.

Given these diverse perceptions about the purpose the code was expected to serve, the multilateral negotiations that took place had the important task of providing a stable, predictable and transparent framework that could facilitate the flow of resources across industrial growth. The code that was to evolve was also meant to minimize any negative effects associated with the activities of transnational corporations. In having this twin-focus on the operations of the activities of transnational corporations and their treatment by governments, the concerns of both home and host countries, as well as the transnational corporations were to be met.

That a code of conduct having twin-objectives, as referred to above, was felt imperative because of the inadequacies of the earlier efforts which were made to deal with the various issues relating to transnational corporations. The OECD countries, in particular, had promoted bilateral investment protection treaties, which were important policy instruments of developed countries. A large number of developing countries had also entered into such treaties primarily to secure foreign investment. The most significant limitation of these treaties was that while the standards of treatment of transnational corporations by their host governments were specified, no mention was made of the corresponding set of standards to govern the behaviour of the transnational corporations. Thus, the bilateral investment treaties, while remaining a part of the international regime governing transnational corporations, fell short of providing a balanced and comprehensive international framework essential for fostering the predictability and stability required for mutually satisfactory relations between transnational corporations and the governments. The multilaterally evolved code was expected to fill this lacuna and to contribute to a reduction of the friction and conflict between the transnational corporations and their host governments.

Objectives of negotiations

The code of conduct was a major endeavour of the world community towards evolving a broad set of rules and regulations governing the operations of transnational corporations. This came as a part of the effort that took place in the 1970s to improve the functioning of the international economic system and building on the initiative of the international business community to prescribe norms for foreign direct investment, as expressed, for instance in the “guidelines for international investment” adopted by the international chamber of commerce. The code was to provide instrumentalities for regulating the whole range of relations between the governments and the transnational corporations and covering a set of issues that were all encompassing.

The negotiations centering around the code took place under the auspices of the commission on transnational corporations, the organisation which took shape within the United Nations system in the mid-1970s. It envisaged a global mechanism that was to be opened to participation by all states.

A draft code, formulated by the intergovernmental working group, a subsidiary body of the commission established in 1975 and covering 48 states, was considered in the negotiations. The first session of this intergovernmental working group it was emphasised by the developed countries that the code ought to be balanced by the establishment of standards for the treatment of transnational corporations in their host countries (implying there by the developing countries), in addition to the transnational corporations most of which had their home based in the developed countries as referred to earlier. The suggestion was accepted by the economic and social council of the United Nations, which stated in its Mexico declaration of July 1980 [Resolution 1980/60,para 6(f)] that the code should, among other objectives, “include provisions relating to the treatment of transnational corporations, jurisdiction and other related matters”.

In substance, the resolution, affirmed that the code should fulfill the following objectives:
a) Be effective, comprehensive, generally accepted and universally adopted,
b) Associate effectively the activities of transnational corporations with efforts to establish the new international economic order and their capabilities with the developmental objectives of developing countries,
c) Reflect the principle of respect by transnational corporations for the national sovereignty, laws and regulations of the countries in which they operate, as well as the established policies of those countries and the right of states to regulate and accordingly to monitor the activities of transnational corporations,
d) Encourage the contribution that transnational corporations can make towards the achievement of developmental goals and established objectives of the countries.

The intergovernmental working group submitted its report to the commission in its eighth session in 1982. This report, though arrived through a consensus, had several unresolved issues, which were central to the code. The unresolved issues related mostly to the treatment of the transnational corporations. The next phase of the negotiations was consequently entrusted to a special session of the commission on transnational corporations, which began its deliberations in 1983 and it was made open to the participation of all states.

Discuss the impact of FDI inflows in developing countries in terms of the direct and indirect implications...

Discuss the impact of FDI inflows in developing countries in terms of the direct and indirect implications that the FDI has for the national income, employment, balance of payments etc. in the host economies.

FDI inflows, generally, have important direct and indirect implications for the national income (output), employment, balance of payments, technological capability, market structure, and other parameters of development in the host economies.

FDIs comprise inflow of productive resources, such as, capital and foreign exchange are, generally, accompanied by flow of entrepreneurial and managerial skills and technology. FDIs complement the domestic savings in financing the capital formation in the host country. Thus FDIs contribute to the generation of output and employment. The foreign exchange inflow augments the supply of foreign exchange, which is often scarce in the developing countries. In most cases, however, the project being set up with FDI is dependent upon imported plant and machinery, and technology. The foreign exchange inflow takes care of these import requirements, partially or fully.

The direct cost of FDI to the host country comprises remittances made on account of dividends on the equity held abroad, interest on loans or suppliers’ credits extended by the foreign investors, royalties and technical fees, for transfer of technology and other services provided by the foreign partner.

Unlike foreign borrowings, servicing remittances, viz., dividends in the case of FDI begin after the project starts making profits. However, the servicing burden of FDI builds up very fast, and consumes considerable foreign exchange resources of the host country. Further, these remittances have the tendency to grow over time as the enterprise consolidates and prospers.

Thus, the direct impact of FDI on the host country includes both positive and negative aspects. The favourable impact is by way of generation of output and employment by complementing the domestic savings and bringing in the much-needed entrepreneurial skills and foreign exchange resources for the developing countries. The adverse impact is on account of growing remittances of dividends, royalties and technical fees in the foreign exchange, which affect the balance of payments. It has been contended, however, that the direct remittances represent only7 a minor part of the total cost of FDIs on the developing host countries. More significant costs are indirect costs as discussed below.

Indirect Impact

The indirect impact of FDIs on LDCs also has both favourable and adverse elements as follows:

Among the indirect favourable effects of FDI one could include improvement in the access of the host country to the international markets through association with the MNEs, exposure to new technologies and organization and management systems. The MNEs can help their developing host countries to expand the manufactured exports with their captive access to marketing outlets in the industrialized countries. They can also help in saving scarce foreign exchange by substituting imports of the host countries. A predominant proportion of FDIs in India has gone into import-substituting projects. Some studies for the Latin American countries have found evidence of favourable spillovers of the presence of foreign enterprises on local enterprises in terms of improved labour productivity.

FDIs can have adverse effects on different parameters of development, such as, balance of payments, local technological capability, employment, market structure, etc.

Balance of Payments

Besides remittances of dividends, royalties and fees, as discussed above, operations of the MNE affiliates can affect the balance of payments of he host countries through their import dependence and export performance relative to that of their local counterparts, and through manipulation of transfer prices.

Import Dependence

The dependence of foreign controlled enterprises on imported capital goods, raw materials, components and spares is, generally, higher than that in the case of their local counterparts. This could be because of the greater familiarity of the foreign investors with the foreign sources of goods, and to provide a market for the products of the other group companies. A number of studies of different countries confirm the tendency of the foreign firms to buy a lesser proportion of inputs from the local markets than their local counterparts.

Export Promotion

It is argued that the foreign enterprise are better equipped to undertake the manufactured exports because of their captive access to information and marketing outlets in the industrialized counties, and their ability to use internationally renowned brand names. The experience had shown, however that the MNEs are very selective about using developing countries as platforms for exports. Expect for a few countries in the southeast and east Asia. The exercise the of the developing countries has been disappointing in this regard. The studies forma number of countries have shown that export performance of foreign affiliates had not been any different, if no worse, than that of their local counterparts. Further a considerable proportion of agreements concluded between the MNEs and their local affiliates include clauses restricting exports of the latter.

Transfer Pricing

The MNEs also use manipulation of transfer process to covertly transfer surpluses of the affiliates to the headquarters. The transfer price is the price at which intra-firm trade takes place. Hence, imports of raw materials spare parts and capital goods of the affiliates from the parent or other associates take place at transfer prices. Since the transfer process are determined by the foreign parent there is ample scope of their manipulation of their advantage. There is considerable evidence form India and other developing countries of indulgence of the MNEs in manipulating transfer prices to the disadvantage of the host nations. The extent of manipulation in certain cases exceeded 100 per cent.
Thus, FDIs affect balance of payments of the host countries not only through initial capital inflows, foreign exchange spent on capital goods imports and servicing remittances, but also through foreign exchange generated through exports or saved through import substitution, imports of raw materials and components which could be unreasonably high and through possible manipulation of transfer prices.

Technology Transfer and Local Capability

FDI is considered to be a vehicle of technology transfer. It is con tended therefore that the FDI flows provide their host countries access to sophisticate and complex technologies. But the theoretical propositions and empirical findings suggest that FDI by itself does not necessarily improve the access of the host countries to more complex technologies.

The recent empirical studies confirm that it is not the more complex or sophisticated technologies that are transferred most through FDI. It is the technology for production of differentiated goods sold under brand names with high advertising and marketing outlays that is most likely to be transferred though FDI. It is because of these tendencies that most developing country governments have evolved entry regulations to screen proposals of FDI and licensing collaborations according to the national prorates and technological gaps.

In any case FDIs or licensing agreements envisage transfer to production know-how. The know-how or design capability is rarely provided by the foreign collaborators to the recipient enterprises and that is the most important component of building local technological capability. The know-how is to be absorbed through learning by doing, reverse engineering, or during the process or product adaptations and R&D activities. in the case of FDI the foreign collaborator is also participating in the management controlling the technical functions. In these cases therefore the chances of the importing enterprise leering through processes such as reverse engineering are very limited. In house R&D activity of the MNEs is usually centralised on a global or regional level, feeding all the affiliates. Several surveys have confirmed the MNEs tendency to concentrate R&D activity near headquarters or in the developed countries.

Thus FDI makes only a limited contribution to local technological capability building in the host countries. They appear to be inferior to licensing or outright purchases of technology as a channel of technology acquisition in terms of contribution to local technological capability.

Choice of Techniques and Employment

An excessive induction of such technologies in labour surplus economies may, therefore create distortions like growing capital scarcity and unemployment. A number of studies comparing factor proportions of technologies employed by the foreign and local firms in a number of developing countries have found evidence of the capital intensity in the former case. Therefore FDIs create fewer jobs per unit of investment than other investments in LDCs.

Market Structure

Entry of the MNEs can affect host country market structures adversely. Possession of intangible assets, such as globally known brand names and their reliance on non-price mode of rivalry viz., through product differentiation and advertising and heavy market promotion raise barriers to the entry of potential local entrants. Besides the MENs sometimes engage themselves into restrictive practices, which are aimed at eliminating the existing or potential competition by margers and acquisitions or by forming cartels. Hence the presence of the MENs generally leads to market concentration. Empirical studies of few countries have confirmed a correlation between FDIs and market concentration even after controlling for common factors.

FDIs can have a wide-ranging impact on the national incomes of host countries, employment balance of payments local technological capability and market structures. Impact on these parameters of development of individual FDI projects can vary widely, depending upon several factors such as its place in the host country’s development priorities organizational structure extent of local participation, choice of technique location, size of market relative to that of the project etc. Host country policies and regulations can play an important role in maximizing the positive impact and minimizing the negative impact.

What new trends do you observe over the last one decade or so in sourcing of materials, components or sub-assemblies?

What new trends do you observe over the last one decade or so in sourcing of materials, components or sub-assemblies? Give your comments citing examples.



SOURCING AND PROCUREMENT
Sourcing and procurement may relate to raw material, parts and components, or semi-finished goods, or finished goods. There are two important issues which are involved in relation to procurement and sourcing strategy:

i) Centralised (concentrated facilities) versus Decentralised (dispersed facilities) approach serving the world market. In other words, to what extent the firm will have integrated manufacturing operations?
ii) Make or buy decisions i.e., whether to buy or subcontract the needed goods, or. To manufacture within the firm’s own facilities.

Before goods can be manufactured, raw materials must be procured. Procurement of raw materials, for instance, is critical for Japan, since it purchases from abroad 100% of its uranium, bauxite, and nickel; virtually 100% of its crude oil and iron ore; 92% of its copper; 85% of its cooking coal; and 30% of its farm products. Trading companies, discussed in Block 1 and with which we hope you are familiar, came into being to acquire the raw materials that are necessary for manufacturing purposes. Procurement from abroad involves problems that are not present to the same extent in domestic sourcing; for example, problems like language, distance, currency, wars and insurrections, strikes, political problems, tariffs, etc.

The importer needs to know how to acquire goods, what duties must be paid, what special laws exist. Sometimes goods are imported into a country and are immediately exported, or are assembled into an intermediate or final product and then exported. When imported goods are exported from a bonded custom warehouse, the entire import duty paid earlier may be refunded. Likewise, when articles manufactured or produced in a country with the use of imported merchandise are exported, a substantial percentage of the duties are refunded as a drawback. In recent years, foreign trade zones (FTZs) have become very popular as an intermediate step between import and final use. We shall revert to this topic a little later.

Managers have to select the best source for the various inputs which are needed for manufacturing a product. They have to decide on the most effective means of obtaining them and have to determine the timing for acquiring them. The firm’s overall objective may be to obtain the best inputs from around the world in order to produce the components and products efficiently. Of course, the managers need to modify this objective in the light of constraints of different political and cultural environments.




Centralised versus Decentralised Approach


To procure goods for world markets, the firm may establish a centralised source or sources. This question is directly related to the firm’s desire to rationalize its production and marketing processes. The main advantages of establishing a centralised source (or sources) are:

• lower production costs through economies of scale
elimination and reduction of costly scheduling problem
• rapid start-up on new products
• reduction of inventories

However the centralised system may give rise to the following disadvantages:

• The firm may not be able to meet the host countries’ demand for local manufacturing. The firm therefore runs the risk of loosing such market.
• The firm may have to compromise with the flexibility of responding to changing market conditions and the consumer preferences.
• If production or sourcing is concentrated in one or few countries, this may make the firm vulnerable to socio-economic and political events (e.g. political uncertainty and strikes etc.) in the given country (or countries) in which major plants are located.

All the firms may not like the centralised sourcing activities. The most favourable conditions for a centralised system are where there is high relationship between the unit cost and the volume produced (the larger the volume the lower the unit cost) and where production system is using a continuous-process type of manufacturing technology (e.g. and chemicals, and petroleum). Sometimes, larger export incentives offered by a host country may also influence in favour of centralised sourcing facility. Export Process Zones (EPZs) have become major sourcing points for many U.S., European, and Japanese firms, partly because of governmental subsidies and partly because of lower labour costs. According to one study, five countries, namely Mexico, Ireland, Taiwan, Hong Kong and Singapore, accounted for 22% of 362 export plants. These along with another five countries (Canada, Belgium, Netherlands, U.K. and Italy) claim 33% of such plants. All of these countries offer substantial incentives to foreign investors.

Some manufacturers may have what is known as global sourcing strategy (a decentralised approach). For example, Nike, which is a producer of sports shoes in the United States, sources more than 90% of its production by contacting with foreign suppliers, mainly from Asia. The company has expanded beyond its home market and increased foreign sales to more than 20% of its total turnover.

It is interesting to note that India is fastly emerging a major sub-contracting source for European companies

India fast becoming a major subcontracting source for European cos
India has been steadily emerging as a subcontracting base for Europe. The European manufacturers, particularly the automobile and machinery builders, are keenly looking at India as a base for the supply of parts, subassemblies, castings, forgings and engineering components.

The recently concluded Hanover Fair ’95, the world’s largest industrial fair, has brought to the fore the almost compelling need of the European industries to source their procurement from countries outside Europe. India is being considered now as a dependable source for such manufactures.

According to Indian industry sources, Mahindra Exports Ltd. (MEL) has tied up with the world’s biggest tractor manufacturer in Germany for supply of tractor parts and components. The company has also tied up with a Spanish company which will supply MEL the tooling for component manufacturing and will buy back the production on a continuous basis.

Another Pune based company, Pratibha Founders, has received a huge order from the Netherlands for supply of aluminium castings, and the volume is so large that this company will have full capacity utilization throughout the year with this single order alone.

Due to the high cost of production and strict environmental laws, German foundries and forging shops are finding it difficult to cater to their user industries cost effectively. Controlling the costs of inputs is such an over whelming consideration today that European and American industries are willing to source their component inputs from any part of the world, where they see price advantage.

Since the volumes of orders involved are very large, even the marginal cost advantage spells big overall saving. This kind of a scenario holds precious opportunities for the Indian foundry and forging industry. The technology of most of major foundry and forging companies in India can be rated as the best among all the developing countries.

The industry already has spare capacity to undertake major jobs. Raw materials, power, skilled labour and logistics are no more a problem. With all counts in its favour, the Indian foundry and forging industry is the most ideal sub-contracting partner for European and American industries, sources here say.

The next two to three years would be very crucial for exports for India’s foundry and forging industry. During this period, if it can establish itself as a price competitive and reliable source for subcontracting, the industry’s hands will be full with business for at least a decade. Hanover Fair, the world’s biggest forum for subcontracting, has provided Indian exhibitors an opportunity to establish worldwide contacts from a single platform.

The Indo-German Chamber of Commerce had organized a joint Indian pavilion in the subcontracting sector at Han over Fair ’95 in order to help medium and small scale companies step into the export market. The IGCC has been organizing such joint participation for last three years by offering complete infrastructural support and facilities to the exhibitors. The country level participation organized by the IGCC provides the medium and small scale exhibitors a large image and helps them attract major and serious customers. The Centre for Promotion of Imports from Developing Countries (CBI), Netherlands, had also supported a group participation of 14 companies in the subcontracting sector and power transmission sector.

Reports from Beijing also indicate that the massive modernisation programme of the Chinese railways and the $20 billion three gorges multipurpose dam project have opened up possibility for Indian subcontracting jobs in China.

The Chinese authorities have already started making enquiries for Indian participation in the railway modernisation programmes, particularly for purchase of Indian rails from the Bhilai steel plant.

The world leaders in power equipment, Asea Brown Boveri (ABB) and Siemens are to take up big contract jobs in the three gorges power project which is expected to have three billion dollars foreign investment.

The project to be completed by the year 2010 is to have huge 18,200 MW of hydel power generating capacity.

A company following global sourcing global sourcing strategy may purchase its requirements from import agents, and negotiations may take place based on home country currency. This is a passive approach. A more aggressive approach may be to have its buyers traveling overseas seeking out sources of supply. Alternatively, it may have purchasing offices located in foreign countries. The personnel overseas may be responsible for quality control, product design, and for supplying materials to foreign fabricators as well as for purchasing and shipping.

The implementation of a global sourcing strategy requires appropriate organizational support, global research on supply sources and personnel experienced in many dimensions of international trade. The buyers of the company must be familiar with foreign exchange risk, tariffs, quotas, international transportation, difference in cultural environment, and many other import issues.

It should be mentioned that the choice between centralised versus decentralised sourcing is not of the either/or type. It has been observed that many firms use both the alternatives. High tariff rates, transportation cost, foreign exchange fluctuations tend to discourage centralised sourcing in certain parts of the world, and for certain products, the firm may use centralised sourcing. In other parts of the world and for other products, it may use a decentralised system. For example, Dow Chemical Company has established larger chemical manufacturing units in West Germany and the Netherlands to supply chemical and petrochemical products for entire European markets, but its consumer oriented products are manufactured in various countries to meet local demands. Such hybrid or mixed strategies involving partial rationalization of production and marketing facilities and partial local manufacturing reflect the influence of the following factors:

1) Technology : Capital intensive industry tend to provide economies of scale on much higher volume through reduction of overhead costs. Capital intensive industries through are more likely to have centralised facilities.

2) Market competitiveness: In an industry where there is a intense competition, there is considerable pressure to reduce unit costs. Consequently, production and marketing rationalization become almost a necessity.


3) Interchangeability of parts: Rationalising the production facility for manufacturing parts etc. is quite difficult unless the products are standardized. Consequently, products which are at the mature stage of their product life cycle are more likely subject to production rationalization.

4) Government demands and pressures : Many developing countries require multinational companies to manufacture locally. The objectives behind this requirement are to achieve self sufficiency and to generate economic and industrial growth. Countries such as India, Indonesia, Malaysia, Brazil and Peru have required local manufacturing, and until recently, have imposed stiff duties and penalties on goods imported from other countries. It may be pertinent to make a distinction between global sourcing strategy and a global strategy (or global logistic strategy). A multinational enterprise following the latter strategy would normally like to have the sourching for its target markets from a centralised system perspective. Rather than determining supply source independently for each market, the enterprise can seek to strengthen its competitive position by considering all the markets simultaneously and by designing a least cost supply strategy for the system as a whole. It may rationalize its manufacturing operations by having an integrated network of plants, each plant may specialize in one or more products or components, and each plant may serve a world or a regional market. Plants may also specialise by stages in the production process and can be located indifferent countries according to location advantages. Extensive trans-shipments of components and finished products between subsidiaries indifferent countries is usually the result of such global (or global logistic) strategy.

The global strategy can reduce unit cost in industries where economies of scale are significant and not fully exploited within the size of national market. Once each subsidiary no longer manufactures a full product line, the management of export activities becomes extremely important. Export orders have to be directed to centre and then allocated to the appropriate subsidiary. Needless to mention the implementation of such a strategy requires the use of export/import expertise, and this capability must be exercised includes harmony with the management of foreign production.

Source-Market Matrix

To help plan production management, the MNE following a global strategy can gainfully employ a source-market matrix. The matrix relates the supply of products of various subsidiaries to the demands for these products in various markets. Each cell in the matrix, as shown in Figure, contains information about the incremental costs of producing one extra unit output and the logistics costs of transporting that unit from one subsidiary (source) to another market.








The production costs of the various subsidiaries will differ because of country specific factors, such as local wage rates. Logistics costs may also vary because of environmental factors, such as optimal transport mode and level of tariffs. The purpose of the matrix is to provide a framework for the MNE to evaluate production and logistics costs in relationship to market demand. The usual objective of the MNE is to avoid both excess production and under production, as the former builds up inventory costs and the latter can lead to stock outs. The MNE has to optimize production by many subsidiaries across many markets. The source-market matrix is a device to focus attention on the integrated nature of its production management.

The source-market matrix shown in Figure is a simple matrix which is limited to focusing on the relationships between three nations. Some MNEs may have operations by having subsidiaries or affiliated companies in 50 or more countries. The matrix could be further sub-divided into major regions within the host nations. Each cell in the matrix is further divided into over-and-under-capacity production cost, as this will differ significantly between plants. The matrix should be updated periodically to reflect other changes in production of logistics costs in the various countries in which the MNE operates.

Sourcing Policies and Practices

One study indicates that European and Japanese companies have rationalized their production systems more than the United States companies. Japanese firms, until production systems more than the United States companies. Japanese firms, until recently, had a preference for exporting from Japan or their off-shore facilities in low wage countries. The ability of the Japanese firms to achieve economies of scale and lower unit cost largely explains their success in the international market place. Competition from the Japanese and European firms has compelled many United States firms to rationalize production and marketing systems. Nearly 40% U.S. exports and nearly 45% of their imports are intrafirms transactions.

According to statistics of the United Nations some 23% of sales by U.S. affiliates were intra company transactions. Such intracompany trade is higher in the mining and petroleum industries than in the manufacturing sector, and is more significant in the affiliates located in developing than in the developed countries. In context, European and Japanese multinational firms claim to use local inputs in large proportions in order to satisfy the host government’s demands and to grant higher degrees of autonomy to their overseas subsidiaries. This is particulary true in relation to developing countries where such demands are most intensive.

The results of the comparative study of U.S. German and Japanese multinational companies show a great deal of convergence in sourcing policies and practices of these three types of multinational companies. Approximately two thirds of the U.S., German and Japanese subsidiaries purchased more than one quarter of their requirements of raw materials, semi-finished and finished goods from their respective parent organizations. Controlling and coordinating the sourcing for the required input is perhaps the first step towards global integration. Through integrated sourcing policy the firm may indeed be able to reduce the cost and perhaps the price of the goods.

Monday, June 15, 2009

Describe the main features of MNCs. Critically evaluate the relationship between MNCs and host countries.

Describe the main features of MNCs. Critically evaluate the relationship between MNCs and host countries.

Multinational Companies (MNCs) are also known as Transnational Corporations (TNCs).

There is, however, according to some, a difference between the MNCs and the TNCs. According to some experts, MNCs produce commodities/products for domestic consumption of the countries in which they operate. The TNCs, on the other hand, concentrate on producing products/commodities to meet the markets of third countries. This difference is not normally made while referring to either MNCs or TNCs. Therefore, an MNC can also be called TNC. In this paper we refer to these international companies as MNCs.

It is important to understand the nature of these companies, and their main features before undertaking any detailed discussion of their culture in the context of host countries in which they operate. For the purpose of this paper an MNC has been defined as one which has its producing and trading activities in a number of countries and which has a central organization regulating the activities of its units, across national frontiers, with specific global objectives.

It may be added here that recently some MNCs have decentralized their decision-making. Some large MNCs with a wide variety of products operating in a large number of countries are organizing their subsidiaries, branches and affiliates on the basis of regional and product based profit centers. This, however, has not radically altered the importance of central decision making in the concerned MNCs. The final decisions on a number of issues of vital importance in such situation still rests with the center i.e the parent organization.

It is important in this context to also refer to the recent debate whether MNCs are losing their national character, that is, the parent company does not belong to a country. For, it is argued by some that the parent company sheds its national character and becomes a global one because the ownership of the company is diverse since a large number of share holders belonging to various countries own the equity shares and multinational banks of various countries finance their operations. Moreover, even the boards of directors of the parent companies have different nationals as their member. It is, therefore, argued that there is no such thing as USA’s MNCs, Japan’s MNSs and the UK’s MNCs etc.

However, the evidence goes against this understanding. It has been found that MNC do retain their national character, because of two important reasons: First, the critical level of ownership of equity shares is still with the original parent. The overwhelming majority of directors on the Board are nationals of the country of origin of the parent company. It is therefore vital to recognize that these companies still retain their national character. Hence even now we have what we can describe as USE’s MNCs, UK’s MNCs and Japan’s MNCs.

It is also important to clarity in this context what one means when one talks of MNC’s culture and the host country. In this paper in MNC’s culture has been totally identified with its corporate objectives, management practices and procedures. A host country is an independent nation state where an MNC has established its business operations through either subsidiaries or branches and affiliates. It is also important here to make a distinction between a developed host country and a developing host country. All the countries of the organization for Economic Cooperation and Development (OECD) are treated as developed host countries and countries treated by the UN as developing countries are treated as developing host countries in this unit. The latter include countries in Asia, Africa and Latin America, excluding of course members of the OECD such as Japan.

The corporate objectives, management practices and procedures of MNCs will differ from country to country. For instance, corporate objectives, management practices and procedures of MNCs from the US differ from those from Japan and Germany. The fact, however, remains that despite a number of variations, MNCs of all Major developed countries possess some common elements which cannot be lost sight of. This understanding will help us to generalise about their business culture.

The main features can be classified as follows:

• MNCs are normally very large in size as measured by the value of their total sales. The average MNC has billions of US dollars as its total sales value which is often equivalent to ormore than the national income of one, two or three large developing countries. In fact, it has been said that such companies form a ‘billion dollar club’. In the eighties, however, there has been growth of small and medium-sized companies which have become MNCs. For instance, 58.4 per cent of all MNCs from Canada, 23 per cent from Japan, 78 per cent from the UK, 43.3 per cent from the USA and 80 per cent from France are small and medium-sized MNCs. No doubt there is a threshold – a certain minimum size which is required for affirm to become an MNC.
• Many MNCs depend more on their foreign sales than on domestic sales. There has been a steady growth of the share of foreign sales to total sales (Table)

• The strength of MNCs lies in the fact that they operate in many product lines. Occasionally, we do have MNCs such as automobile giants and the IBM which have confined to a narrow line of products. But such cases are exceptions. Diversification into various product lines was earlier confined to the MNCs from the US in the sixties and early seventies. But now MNCs of all counties have accepted product diversification as a corporate objective (Table)

• MNCs often preside over a broad range of products with vastly different technical and strategic requirements. This range adds to the complexity of managers’ problems. While one line of business may be pressed hard by competition, another may be discovering newer and greener pastures. While some of the activities of MNCs make great demands as the resource of the network, others may be providing supply of funds. This diversity provides MNCs with extraordinary flexibility in managing their corporations globally.

• The MNCs have yet another advantage, their geographical diversity. When an enterprise takes its first plunge into foreign waters, it normally moves with some caution. Once committed to the international pattern, MNCs expand their geographical reach with great rapidity. This applies to MNCs were operating in 170 countries and the Europe-based companies in more than 114 countries (Table)

• Most of the MNCs have great strength in the realm of technology. They spend billions of dollars on research and development. They also possess management and marketing technologies.

Now, we shall discuss the issues related with the MNCs culture and host countries.








Source: UNCTC, Transnationals Corporations in World Development Trends and Prospects (U.N., N.Y., 1988), p.36.




Source: Raymond Vernon, Storm over the Multinationals: The Issues (Macmillan, London, 1977).


MNCs AND HOST COUNTRIES’ GOVERNMENT POLICIES

One of the most important areas of debate has been the MNCs and host government policies. The objectives of MNCs and host countries’ governments have a number of areas where conflict may occur. First, whose jurisdiction have the MNCs to accept in the event of conflicts between the host country and the home country of the MNCs. There are a number of cases where the MNCs have asserted the home government’s rights. This had led to conflict among all the three – the MNC, the host government and the home government.

Host government policies may encourage or discourage MNCs. What policies host government would follow are linked directly with the business objectives and culture of the MNCs.

In the present context, the developed host countries have broadly similar policies that provide relatively free operation of MNCs in their economies. This can be seen in the expansion of foreign direct investment made by the MNCs largely in developed countries with the US receiving nearly 40 per cent of foreign direct investment mainly by the MNCs.

The emergence of ‘Europe 1992’ has specific policy orientations to encourage MNCs’ operations in European Community. Even Japan is liberalizing. The Great Shift has taken place in developing host countries. A large number of developing countries are using their policies to attract MNCs. Before analyzing the policy shifts it is useful to identify various elements of developing host countries’ policies towards MNCs which ere in the center of the debate in the eighties. It has often been argued that developing countries which have selective foreign direct investment (FDI) and transfer of technology policies create disincentives to MNCs. The selective policies may be manifested in one or more of the following:

• Treatment of MNCs under the laws of the country which may deprive them of national or equal treatment;
• Administrative rules and regulations governing MNCs’ ventures may result in a high degree of discretion and lack of transparency in decision making;
• Imposition of management and labour policies;
• Imposition of management and labour policies;
• Equity restrictions;
• Lack of continuity or uncertainty of FDI and technology collaboration policies; and
• Threat of nationalization and expropriation and limitations set on remittances of profits and capital.

Many developing countries in the eighties have made a large number of policy changes to attract MNCs. A few chief elements have been highlighted in the following pages.

Many African states have enacted “Investment Codes” designed to promote both domestic and foreign investment. Such usually provide for the grant of certain general guarantee against expropriation or nationalization without fair compensation and non-discriminatory treatment and repatriation of capital and profits. A number of African countries have established investment coordination agencies with a view to promoting investment by TNCs.

It is notable that African socialist countries also appear to be moving, albeit in a manner best suited to their specificities, in the general direction of acceptance of FDI from MNCs.

In Asia severalcountries have amended to varying extents their foreign investment policies. South Korea which had a rather restrictive foreign investment policy had liberalized by streamlining and simplifying procedures. A foreign investor who does not seek majority ownership seeks no concessions and in fact has less than $ 1 million investment, gets automatic approval. Service sectors are getting open to MNCs.

Malaysia has postponed the condition requiring participation of Bhumiputras in the equity of foreign ventures. China has also permitted foreign investors and MNCs and simplified procedures and thus emerged as the largest recipient of foreign direct investment. Within seven years of opening its door to foreign investors, China has become one of the largest recipients of foreign direct investment. Among all developing countries China was earlier particularly interested in acquiring advanced technology, management skills and international distribution channels. Between 1979 andmid-1987, the cumulative inflows of FDI to China amounted to about $ 9 billion. Approved investment projects over this period totaled nearly $ 20 billion. It is important to recognize the 2/3rds of the investment has been in the service sector. Since 1986 however, due to certain difficulties, FDI flows to China have, however, declined.

Even the Middle Eastern Countries have liberalized the codes concerning foreign direct investment. The Algerian code strikingly illustrates the trend towards liberalization, primarily because it amends an earlier law that was considerably more restrictive. While equity participation is still subject to restrictive clauses other procedures and restrictions have been relaxed.

The most dramatic changes have taken place in the FDI laws in the Latin American countries. These countries, especially the Andean group of countries, Brazil, and Chile had predominance of control rather than encouragement in their FDI policies. They have effected a number of changes in their laws and policies. For example, Columbia, a member of the Andean group, acting within its basic provision of Decision 24, raised the ceiling of profit remittances.

It is important to recognize that some developing countries had nationalized MNCs’ subsidiaries in their countries. This measure was taken as a last resort when the conflicts arose with MNCs. The approach of developing countries to the nationalization issue is an indication of the change that has taken in the attitude of the developing countries to MNCs. It is significant that while during the period 1970-75 nearly 336 companies in developing countries were nationalized, accounting for 58.5 per cent of the total nationalizations, during the period 1980–85 only 15 companies 2.6 per cent of the total were nationalized.

Apart from relaxation of foreign direct investment policies, a large number of developing countries have entered into bilateral investment treaties. The developed countries in a bid to secure assurance for the protection of investments originating from their respective home countries have sought to negotiate these agreements which provide security to their MNCs . On the other hand, the developing countries, faced with a number of difficulties onforeign exchange account, have themselves resorted to bilateral investment measures.

Some 100 bilateral investment treaties have been concluded since 1980 bringing the total number of these agreements to approximately 270. Majority of these countries are in Africa and South-East Asia. Latin American countries have not concluded such agreements.

These agreements cover issues such as fair and equitable treatment, national treatment and most favoured nation treatment, nationalization/expropriation modalities of compensation and dispute settlement.

At the multilateral level, efforts are being made to assure protection to MNCs. An important endeavour has been the Multilateral Investment Guarantee Agency (MIGA), a new member of the World Bank group which has a specialized mandate to encourage equity investment and other direct investment flows to developing countries through the mitigation of non-commercial investment barriers especially political risks. To carry out this mandate the MIGA offers investment guarantees against non-commercial risks. A large number of developing countries including India have become its members.

How do MNEs try to develop and maintain commitment of the individual managers?

The behaviour of individual managers within the organisation is an important concern of top management of MNEs. How do MNEs try to develop and maintain commitment of the individual managers? Give examples.

PATTERN OF EVOLUTION
There are two related processes involved in the growth of a domestic firm to an international one. These are: geographic dispersion of corporate resources and corresponding changes in organizational development. One can classify the evolutionary pattern of MNEs from purely domestic company to a transnational corporation into five types. The organization structure and characteristics of these types are given in table.





A company gets into foreign markets by starting export sales to other countries. The growth in international business evolves from the export department to the international division, world wide product, or mixed matrix structures. Chandler’s thesis of “structure follows strategy” can be explained in terms of the pattern of evolution of multinational business organization. It is the strategy of an MNE, which determines the structural design of the organization by enabling it to achieve its objectives. We shall now discuss different types of organizational structures as shown in Fig.








Type-A domestic oriented firm can either be organized on functional basis or product group basis. The former is more prevalent when the firm has a narrow product range. Most of the overseas sales occur due to unsolicited orders. As, the orders are small in relation to domestic market, the marketing department/division will look after both domestic sales and exports. All sales, whether domestic and export, are looked after by marketing manager. However, separate supervisors may be appointed to take care of domestic or export sales.

In cases where the firm has a wider product line, it might have organized on the basis of product groups. Each product group division will have all the functional departments. In such a situation, the exports from each product group may be small compared to the domestic market. In such a situation, each group handles exports separately. As exports are small, the firm does not need to move corporate resources to fully exploit the foreign markets (Figure).

As exports start increasing in proportion to its total sales, the company may think of having a separate export department with the necessary specialists to facilitate the exploitation of foreign markets. The export effort gets centralised in the corporation and a separate is set up. This is shown in Figure. The firm may be organized on functional or on product group basis. As the export profit may be more than the domestic, the corporation tries to shift from the staff function of the export department to the line functions in its overseas activities.




Type-B organization creates tension when the product division is unable to meet the export orders. The firm may also realize that the exports are not necessarily the only means of entry into the foreign markets. The optimum entry may be found in some other alternatives, lime licensing or direct investments. Such decisions may require a kind of search, which is free from functional or geographic bias. At that time, the firm moves to establish a full-fledged international division as against just an export department (see Figure)




Subsidiaries in several companies my be set up. The international division coordinates all overseas operations (subsidiaries businesses, franchises, govt. ventures, etc.) of the company. The subsidiaries in foreign countries are often organized by regions which report to the international division. The importance of international division lies in the fact that it provides a base or “umbrella” for the international operations of the company. The working of the subsidiaries abroad is balanced in a manner so that optimum yields are achieved. This form may help an MNE to allocate resources or make investment worldwide.

The international division type of structure may sometimes create frictions between domestic and international divisions, such as divided loyalties, completion in attracting competent operating personnel, etc. The international division, in course of time, may get isolated from other segments of the corporate headquarters. It may become an organization in itself. Decisions may be taken which are unwholesome from the total point of view. As long as it does not depend on the corporate resources, it may tend to operate independently. The international division may enter into various contractual arrangements, including joint ventures in overseas markets.

Such an organization is suitable under the following conditions:

- When foreign sales are relatively small to the domestic sales.
- When activities are spread over a limited number of countries,
- When product lines are few, and
- When the demand pattern is homogeneous.

Type-D structure emerges when the international operations continue to grow. The critical psychological level is reached when the international activities become equal or greater than any one of the activities of the demestic division. At this stage, strains may develop due to the size of operations and heavy flow of communications. The international division gives way to product groups which are given, concurrently, the worldwide responsibility in case of wide product line companies. A worldwide product based organization is responsible for production, marketing and profitability of products throughout the world. A comparatively narrow product line company will organize itself into and have a region-wide integration e.g., North American, Latin American, Western Europe, Asia and so on. (see Figures)






The units in the countries within a region are likely to be fairly interdependent. A firm at the stage of its evolution is a multinational firm. The ownership and management of the parent corporation is essentially with the materials of one (i.e., parent) country. The firm has units/ subsidiaries in different countries but its production system is integrated internationally (i.e., centralised control of production). The centralised control is leased primarily on ownership, i.e., equity based control. Most top corporate managers are novice-country materials. Initially all decision making in relation to subsidiaries may be centralised at the headquarters. However, as the firm grows overseas, political pressures develop to compel greater local control and newer subsidiary autonomy. It is also quite possible that as the firm gathers more environmental expertise in headquarters and perceives more clearly the advantages of greater integration, it will attempt to reestablish central control over its foreign operations.

Type-E transnational firm attempts to integrate worldwide operations, and seeks to serve the stakeholders in each nation. A transnational firm is owned and managed multinationally, i.e., ownership and management of the parent corporation resides in the hands of the nations of more than one country. The decisions making may be centralised, but is free of national bias, except as legally imposed. The firm loses loyalty to a single nation. The members of a transnational firm develop loyalty to the firm of a sort that transcends national identity. The national outcome is that, convert of psychologically based national bias indecision making is eliminated and this may result in better allocation of corporate resources. When a multinational firm acquires the character of transnational firm and in the process loses its hither to national loyalty, it may bring the latter to some kind of friction with its (establish) parent government. Thus, the evolution of a multinational to a transnational firm may bring with its significant changes in its behaviour. A transnational firm may generally have a matrix structure which tries to integrate three dimensions: functional areas, product lines and regions. This provides sufficient decentralization to national managers to meet regional needs and the needs of product lines. However, there is a centralised coordination system (Figure).

It has been observed that the traditional organizational structure (independent international division) is now changing fast into global product divisions because of the inherent competitive advantages of the latter. The benefits such as cost effectiveness, improved communication and resource transmission, and above all, a global strategic focus are the main reasons for a more worldwide organization. Thus, an MNE goes through a series of structural changes in search of more suitable design fitting its strategy. The organizational structure keep on changing in response to the strategies adopted by an MNE.