International business competing in the global marketplace 10th edition hill solutions manual

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Chapter 09 - Regional Economic Integration

Regional Economic Integration

Learning objectives •

Describe the different levels of regional economic integration.

•

Understand the economic and political arguments for regional economic integration.

•

Understand the economic and political arguments against regional economic integration.

•

Explain the history, current scope, and future prospects of the world’s most important regional economic agreements.

•

Understand the implications for business that are inherent in regional economic integration agreements.

9 8

This chapter discusses regional economic integration, agreements among countries within a geographic region to achieve economic gains from the free flow of trade and investment among themselves.

There are five levels of economic integration. In order of increasing integration, they include free trade area, customs union, common market, economic union, and full political union.

Integration is not easily achieved or sustained. Although integration brings benefits to the majority, it is never without costs for the minority. Concerns over sovereignty often slow or stop integration attempts.

The creation of single markets in the EU and North America means that many markets that were formerly protected from foreign competition are now more open.

This creates major investment and export opportunities for firms within and outside these regions.

The free movement of goods across borders, the harmonization of product standards, and the simplification of tax regimes make it possible for firms based in a free trade area to realize potentially enormous cost economies by centralizing production in those locations within the area where the mix of factor costs and skills is optimal.

The opening case discusses the complicated case of Mexican tomato growers, U.S. tomato growers, and the pricing structure that was in place once NAFTA went into effect. The closing case explores the implications of a recent ruling by the European Court of Justice that allows consumers to bypass agreements regarding the exclusive rights to local broadcasts of Premier League soccer matches.

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Chapter 09 - Regional Economic Integration

OUTLINE OF CHAPTER 9: REGIONAL ECONOMIC INTEGRATION Opening Case: Tomato Wars Introduction Levels of Economic Integration The Case for Regional Integration The Economic Case for Integration The Political Case for Integration Impediments to Integration The Case Against Regional Integration Regional Economic Integration in Europe Evolution of the European Union Political Structure of the European Union The Single European Act The Establishment of the Euro Enlargement of the European Union Management Focus: The European Commission and Intel Country Focus: Creating a Single European Market in Financial Services Country Focus: The Greek Sovereign Debt Crisis Regional Economic Integration in the Americas The North American Free Trade Agreement The Andean Community Mercosur Central American Common Market, CAFTA, and CARICOM Free Trade Area of the Americas Regional Economic Integration Elsewhere Association of Southeast Asian Nations Asia-Pacific Economic Cooperation Regional Trade Blocs in Africa Focus On Managerial Implications Opportunities Threats Chapter Summary Closing Case: I Want My Greek TV!

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Chapter 09 - Regional Economic Integration

CLASSROOM DISCUSSION POINT Choose either the European Union or the North American Free Trade Area, and then ask students to think about what economic integration means for companies inside the bloc.

Then, ask students to consider economic integration from the perspective of a firm outside the bloc.

Next, ask students to consider economic integration from the perspective of a consumer.

Try to organize student responses in a positive/negative chart on the board, and then at the end of the discussion, ask students whether they would support economic integration or not.

OPENING CASE: Tomato Wars The opening case explores the complicated case of importing tomatoes from Mexico and the impact on both sides of the border. When NAFTA went into effect, tariffs on imported tomatoes from Mexico were dropped. U.S. growers firmly believed that they would lose much of their business to their Mexican counterparts. The U.S. growers lobbied the government to set a minimum floor price for Mexican tomatoes, with the idea being that such a pricing structure would stop Mexican producers from cutting prices below the floor. As it turned out, the deal didn’t offer much protection to U.S. tomato growers.

1. Explore the U.S. growers’ sentiment that they were being shut out of the local tomato market by the low prices agreed to by both countries. How does Mexico’s competitive wages and growing conditions help the Mexican growers?

2. Ask students to explain the concept of Mexico dumping tomatoes on the U.S. market.

How did that hurt the U.S. growers?

3. When Florida growers petitioned the government to scrap the pricing agreement, many U.S. business owners who do extensive business with Mexico cried foul. What was their position when it came to how their own businesses would be hurt by such a government agreement?

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Chapter 09 - Regional Economic Integration

LECTURE OUTLINE This lecture outline follows the Power Point Presentation (PPT) provided along with this instructor’s manual. The PPT slides include additional notes that can be viewed by clicking on “view,” then on “notes.” The following provides a brief overview of each Power Point slide along with teaching tips, and additional perspectives.

Slide 9-3 Introduction Regional economic integration refers to agreements between countries in a geographic region to reduce tariff and nontariff barriers to the free flow of goods, services, and factors of production between each other.

Despite the rapid spread of regional trade agreements designed to promote free trade, there are those who fear that the world is moving toward a situation in which a number of regional trade blocks compete against each other. In this scenario of the future, free trade will exist within each bloc, but each bloc will protect its market from outside competition with high tariffs.

Slides 9-4 through 9-7 Levels of Economic Integration The five levels of economic integration are: free trade area, customs union, common market, economic union, and political union.

The most enduring free trade area in the world is the European Free Trade Association.

EFTA currently joins four countries--Norway, Iceland, Liechtenstein, and Switzerland.

Other free trade areas include the North American Free Trade Agreement (NAFTA).

Another Perspective: A site with information and additional links on NAFTA is available at {http://www.fas.usda.gov/itp/Policy/NAFTA/nafta.asp}. The site includes downloadable power point presentations on the benefits of NAFTA. Another Perspective: To find out more about EFTA, go to {http://www.efta.int/}, and click on “EFTA AELE.” From here you can click on several icons to get quick facts, more in-depth reports, information on the European Economic Area, and many other issues related to EFTA. Customs unions around the world include the current version of the Andean Pact (between Bolivia, Colombia, Ecuador, and Peru).

Currently, Mercosur, the South America grouping that includes Brazil, Argentina, Paraguay, and Uruguay, is aiming to eventually establish itself as a common market.

The European Union (EU) is an economic union, although an imperfect one since not all members of the EU have adopted the euro, the currency of the EU, and differences in tax rates across countries still remain.

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Chapter 09 - Regional Economic Integration

Slide 9-8 The Economic and Political Case for Integration Regional economic integration can be seen as an attempt to achieve additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as the WTO. The political case for integration has two main points: (1) by linking countries together, making them more dependent on each other, and forming a structure where they regularly have to interact, the likelihood of violent conflict and war will decrease, and (2) by linking countries together, they have greater clout and are politically much stronger in dealing with other nations.

Slide 9-9 Impediments to Integration There are two main impediments to integration: • although a nation as a whole may benefit significantly from a regional free trade agreement, certain groups may lose • concerns over national sovereignty Whether regional integration is in the economic interests of the participants depends upon the extent of trade creation as opposed to trade diversion. Trade creation occurs when low cost producers within the free trade area replace high cost domestic producers. Trade diversion occurs when higher cost suppliers within the free trade area replace lower cost external suppliers. A regional free trade agreement will only make the world better off if the amount of trade it creates exceeds the amount it diverts.

Slides 9-10 and 9-11 Regional Economic Integration in Europe There are two trade blocks in Europe: • the European Union (EU) • the European Free Trade Association The EU is by far the more significant, not just in terms of membership, but also in terms of economic and political influence in the world economy.

Slides 9-12 and 9-13 Evolution of the European Union The EU is the product of two political factors: • devastation of two world wars on Western Europe and the desire for a lasting peace • European nations’ desire to hold their own on the world’s political and economic stage.

The forerunner of the EU was the European Coal and Steel Community, which had the goal of removing barriers to trade in coal, iron, steel, and scrap metal formed in 1951.

The EEC was formed in 1957 at the Treaty of Rome. While the original goal was for a common market, progress was generally very slow.

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Chapter 09 - Regional Economic Integration

Another Perspective: The EU web site is {http://europa.eu/index_en.htm}. The site contains a broad array of information about the historical role and current activities of the EU in the global economy.

The Single European Act called for the removal of border controls, mutual recognition of standards, open public procurement, a barrier free financial services industry, no currency exchange controls, free and open freight transport, and freer and more open competition.

Slide 9-14 Political Structure of the European Union The main institutions of the EU are: • the European Council (ultimate controlling authority within the EU) • the European Commission (responsible for implementing aspects of EU law and monitoring member states to ensure they are complying with EU laws) • the European Parliament (debates legislation proposed by the commission and forwarded to it by the council) • the Court of Justice (the supreme appeals court for EU law).

Slides 9-15 and 9-16 The Establishment of the Euro The Treaty of Maastricht, signed in 1991, committed the EU to adopt a single currency, the euro, by January 1, 1999. The euro is used by 17 of the 27 member states. By adopting the euro, the EU has created the second largest currency zone in the world after that of the U.S. dollar.

Since its establishment January 1, 1999, the euro has had a volatile trading history with the U.S. dollar. Initially, the currency fell in value relative to the dollar, but has since strengthened.

Another Perspective: The European Union has a web page devoted to the euro {http://ec.europa.eu/economy_finance/euro/index_en.htm}. Students can explore the site and click on the pages to see pictures of the coins and notes, the advantages of participating in the euro zone, and frequently asked questions about the euro.

Another Perspective: The European Central Bank maintains a web site with current information on the euro. The site is available at {http://www.euro.ecb.int/}.

Another Perspective: At one point in time, joining the Euro Zone had been the goal of many Eastern European countries. Now however, given the recent financial crises that is threatening the future of the euro, many are rethinking their plans. To learn more, go to {http://www.businessweek.com/magazine/content/11_27/b4235017725502.htm}.

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Chapter 09 - Regional Economic Integration

Slide 9-17 Enlargement of the European Union Several countries, particularly from Eastern Europe, have applied for membership in the EU. In December of 2002, the EU formally agreed to accept the applications of 10 countries, and they joined on May 1, 2004. Today, membership is up to 28 countries, with Croatia joining in July of 2013.

Slides 9-18 and 9-19 Regional Economic Integration in the Americas The North American Free Trade Agreement (NAFTA) is the most significant attempt at economic integration in the Americas. Other efforts include the Andean group and Mercosur. In addition, there are plans to establish a hemisphere wide Free Trade Area of the Americas (FTAA.) Slides 9-20 through 9-23 The North American Free Trade Agreement The free trade agreement between the United States, Canada, and Mexico became law January 1, 1994.

Another Perspective: More on NAFTA can be found at {http://www.fas.usda.gov/itp/Policy/NAFTA/nafta.asp}.

Following approval of NAFTA by the U.S. Congress a number of other Latin American countries indicated their desire to eventually join NAFTA. Currently the governments of both Canada and the U.S. are adopting a wait and see attitude with regard to most countries.

Another Perspective: Many organizations are anxious to take advantage of the opportunities offered by NAFTA. The NAFTA Register {http://www.naftaregister.com/}is a directory of export management companies, export service providers, and trading companies that want to profit from NAFTA by helping buyers and selling take advantage of NAFTA related opportunities.

Slide 9-24 The Andean Community The Andean Pact, originally formed in 1969, was based on the EU model, but was far less successful in achieving its stated goals. In 1990, the Andean Pact was re-launched, and now operates as a customs union.

Another Perspective: To see new developments with the Andean Community go to {http://www.comunidadandina.org/endex.htm}.

Slide 9-25 Mercosur In some industries Mercosur is trade diverting rather than trade creating, and local firms are investing in industries that are not competitive on a worldwide basis.

Another Perspective: Mercosur's website, which includes a broad array of useful information, can be accessed at {http://www.sice.oas.org/trade/mrcsr/mrcsrtoc.asp}.

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Chapter 09 - Regional Economic Integration

Slide 9-26 Central American Trade Agreement Market and CARICOM

There are two other trade pacts in the America, the Central American Trade Market and CARICOM, although neither has made much progress as yet.

Slide 9-27 Free Trade of the Americas If the FTAA is established, it will have major implications for cross-border trade and investment flows within the hemisphere. The FTAA would create a free trade area of 850 million people.

Another Perspective: Additional information on the Free Trade of the Americas can be found at {http://www.ftaa-alca.org/alca_e.asp}.

Slide 9-28 Regional Economic Integration In Asia Several efforts have been made to integrate in Asia One of the most successful is the Association of Southeast Asian Nations (ASEAN) Slides 9-29 and 9-30 Association of Southeast Asian Nations Formed in 1967, ASEAN currently includes Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand, and, most recently, Vietnam, Myanmar, Laos, and Cambodia. The basic objectives of ASEAN are to foster freer trade between member countries and to achieve some cooperation in their industrial policies.

Slides 9-31 and 9-32 Asia-Pacific Cooperation APEC currently has 21 members including such economic powerhouses as the United States, Japan, and China. The stated aim of APEC is to increase multilateral cooperation in view of the economic rise of the Pacific nations and the growing interdependence within the region.

Another Perspective: For more on APEC, go to its web site at {http://www.apec.org/}.

Slide 9-33 Regional Trade Blocks in Africa There are nine trade blocs on the African continent however progress toward the establishment of meaningful trade blocs has been slow.

Slide 9-34 Implications for Managers The EU and NAFTA currently have the most immediate implications for business.

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Chapter 09 - Regional Economic Integration

The greatest implication for MNEs is that the free movement of goods across borders, the harmonization of product standards, and the simplification of tax regimes, makes it possible for firms to realize potentially enormous cost economies by centralizing production in those locations where the mix of factor costs and skills is optimal. Through specialization and shipping of goods between locations, a much more efficient web of operations can be created.

Just as the emergence of single markets in the EU and North America creates opportunities for business, so it also presents a number of threats.

CRITICAL THINKING AND DISCUSSION QUESTIONS QUESTION 1: NAFTA has produced significant benefits for the Canadian, Mexican, and U.S. economy. Discuss.

ANSWER 1: NAFTA’s proponents argue that the agreement should be viewed as an opportunity to create an enlarged and more productive base for the U.S., Canada, and Mexico. As low-income jobs move from Canada and the United States to Mexico, the Mexican economy should be strengthened giving Mexico the ability to purchase highercost American and Canadian products. The net effect of the lower income jobs moving to Mexico and Mexico increasing its imports of high quality American and Canadian goods should be positive for the American and Canadian economies. In addition, the international competitiveness of U.S. and Canadian firms that move production to Mexico to take advantage of lower labor costs will be enhanced, enabling them to better compete with Asian and European rivals.

QUESTION 2: What are the economic and political arguments for regional economic integration? Given these arguments, why don't we see more substantial examples of integration in the world economy?

ANSWER 2: The economic case for regional integration is straightforward. As we saw in Chapter 5, unrestricted free trade allows countries to specialize in the production of goods and services that they can produce most efficiently. If this happens as the result of economic integration within a geographic region, the net effect is greater prosperity for the nations of the region. From a more philosophical perspective, regional economic integration can be seen as an attempt to achieve additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as the WTO. The political case for integration is also compelling.

Linking neighboring economies and making them increasingly dependent on each other creates incentives for political cooperation between neighboring states. Also, the potential for violent conflict between the states is reduced. In addition, by grouping their economies together, the countries can enhance their political weight in the world.

Despite the strong economic and political arguments for integration, it has never been easy to achieve (on a meaningful level). There are two main reasons for this. First, although economic integration benefits the majority, it has its costs. While a set of nations as a whole may benefit significantly from a regional free trade agreement, certain 9-9 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 09 - Regional Economic Integration

groups may loose. The second impediment to integration arises from concerns over national sovereignty.

QUESTION 3: What in general was the effect of the creation of a single market and a single currency within the EU on competition within the EU? Why?

ANSWER 3: By creating a single market and currency, member countries can expect significant gains from the free flow of trade and investment. This will result from the ability of the countries within the EU to specialize in the production of the product that they manufacture the most efficiently, and the freedom to trade those products with other EU countries without being encumbered by tariffs and other trade barriers. In terms of competition, the competition between European firms will increase. Some of the most inefficient firms may go out of business because they will no longer be protected from other European companies by high tariffs, quotas, or administrative trade barriers.

Companies from those countries that have not adopted the euro may find that their costs are higher as they deal with currency exchanges. In addition, because it will be easier to compare prices across markets, firms in the euro zone will be pushed to lower prices and become more efficient.

QUESTION 4: Do you think it is correct for the European Commission to restrict mergers between American companies that do business in Europe? (For example, the European Commission vetoed the proposed merger between WorldCom and Sprint, both U.S. companies, and it carefully reviewed the merger between AOL and Time Warner, again both U.S. companies.)

ANSWER 4: Many students will probably suggest that the European Commission has a right to regulate the European market, even if the regulation involves American companies. Students taking this perspective will probably suggest that such restrictions should be made independently of other considerations, even when the parent governments of the companies have approved the mergers. Other students however, may argue that the European Commission does not have the right to restrict a merger that has been approved by parent governments. In doing so, the European Commission is in effect protecting domestic companies from foreign competition, and violating the spirit of the WTO. QUESTION 5: What were the causes of the 2010–2012 sovereign debt crisis in the EU? What does this crisis tell us about the weaknesses of the euro? Do you think the euro will survive the sovereign debt crisis?

ANSWER 5: Since 2008, the euro has weakened, reflecting persistent concerns over slow economic growth and large budget deficits among several EU members, particularly Greece, Portugal, Ireland, Italy, and Spain. Before the global recession, the governments of these five countries had sharply increased their government debt to finance public spending. By 2010, private investors became increasingly concerned that these countries would not be able to service their sovereign debt, particularly because of the economic slowdown. Investors sold off government bonds of troubled nations, driving down bond prices and driving up the cost of government borrowing. Students’ answers to the 9-10 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 09 - Regional Economic Integration

question about the euro’s long-term survival will vary; however, time will tell if the member countries can get back on their feet financially, which will stabilize the euro.

QUESTION 6: How should a U.S. firm that currently exports to only ASEAN countries respond to the creation of a single market in this regional grouping?

ANSWER 6: A U.S. business firm that is currently exporting to only ASEAN countries should seriously consider opening a facility somewhere in this grouping, as the economics of a common market suggest that outsiders can be at a disadvantage to insiders. The opening of borders within the ASEAN bloc also has the potential to increase the size of the market for the firm. Of course it is possible, after careful consideration, that exporting may still be the most appropriate means of serving the market.

QUESTION 7: How should a firm with self-sufficient production facilities in several ASEAN countries respond to the creation of a single market? What are the constraints on its ability to respond in a manner that minimizes production costs?

ANSWER 7: The creation of the single market means that it may no longer be efficient to operate separate duplicative production facilities in each country. Instead, the facilities could either be linked so that each specializes in the production of only certain items or several sites should be closed down and production consolidated at the most efficient locations. Existing differences between countries as well as the need to be located near important customers may limit a firm’s ability to fully consolidate or relocate production facilities for production cost reasons. Minimizing production costs is only one of many objectives. For example, location of production near R&D facilities can be critical for new product development. The location decision needs to examine long run economic success, not just cost minimization.

QUESTION 8: After a promising start, Mercosur, the major Latin American trade agreement, has faltered and made little progress since 2000. What problems are hurting Mercosur? What can be done to solve these problems?

ANSWER 8: Mercosur originated in 1988 as a free trade pact between Brazil and Argentina. The pact was expanded in 1990 to include Paraguay and Uruguay with the goal of becoming a full free trade area by 1994, and a common market sometime after.

While initially considered a success, critics began to question whether the trade diversion effects of Mercosur outweighed it trade creation effects. Then, in 1998 member states slipped into a recession and in 1999, Brazil’s financial crisis led to a significant devaluation of its currency creating further turmoil. Finally, in 2001, Argentina beset by economic stresses asked that the customs union be temporarily suspended, effectively ending Mercosur’s quest to become a fully functioning customs union. However, in 2003, Brazil’s new president announced his support for a revitalized and expanded Mercosur that would be modeled after the EU, but by 2011, little progress had been made.

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Chapter 09 - Regional Economic Integration

Another Perspective: Students can check the current status of the agreement online {http://www.sice.oas.org/trade/mrcsr/mrcsrtoc.asp}.

To solve the problems of Mercosur, the countries should reduce or eliminate high tariffs on products that can be produced more efficiently in other parts of the world. It should strive to develop industries in which it has a comparative advantage and direct its financial resources to those industries. Finally, it should begin to develop an economy that fosters the free flow of trade and goods throughout the region.

QUESTION 9: Would establishment of a Free Trade Area of the America’s (FTAA) be good for the two most advanced economies in the hemisphere, the United States and Canada? How might the establishment of FTAA impact the strategy on North American firms?

ANSWER 9: In 1994, a Free Trade of the Americas (FTAA) was proposed. If the agreement comes about, it would effectively create a free trade area of nearly 800 million people responsible for more than $18 trillion in GDP in 2008. However, the U.S., while initially a strong advocate of the agreement, has lessened its support for the FTAA recently. The question of whether the agreement is good for the U.S. and Canada will likely produce a lively debate among students.

CLOSING CASE: I Want My Greek TV! The closing case explores the fallout from a recent ruling by the European Court of Justice on the rights of companies like Sky Broadcasting Corporation to limit local viewing options for consumers. Prior to the ruling Sky Broadcasting and ESPN had exclusive rights to show broadcasts of English Premier League soccer matches. Under the agreements, the companies divided the European market into segments and charged consumers different prices in each market. The ruling now gives consumers the right to access cheaper broadcasts being shown in other European Union markets. The Court defends the ruling arguing that it upholds the basic principles of a single Market system. exported from the United States. Discussion of the case can revolve around the following questions: QUESTION 1: Why do you think the English Premier League has historically charged different prices for broadcasting rights in different European markets?

ANSWER 1: The Premier League has charged different prices based on local demand for its soccer broadcasts. The highest prices were charged in the United Kingdom where soccer is extremely popular.

QUESTION 2: Do you think the European Court of Justice was right to rule that the league could not stop people from buying Premier League feeds from other countries?

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Chapter 09 - Regional Economic Integration

ANSWER 2: Student answers will vary. Sky Broadcasting and ESPN pay the Premier League billions of dollars for the rights to broadcast the soccer games. Individual, small business owners have to spend a lot of money to be able to broadcast the games to their customers.

QUESTION 3: Who benefits from the EU ruling? Who will the losers be?

ANSWER 3: Small business owners will benefit from the ruling. However, if the Premier League clubs begin to get less revenue from Sky and ESPN, it may have a profound effect on the players the clubs can recruit and the wages they can afford.

QUESTION 4: If you were running the English Premier League, what would your strategy be on broadcast rights going forward?

ANSWER 4: Student answers will vary. One tactic would be to negotiate with ESPN and Sky Broadcasting to come up with a better financial deal for the small business owners— thus trying to get them not to buy the feed from other countries. Another tactic would be to raise the cost of the TV feed in the smaller markets to make the small business owners pay more to decode the TV feeds from other countries.

INTEGRATING iGLOBES There are several iGLOBE video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:

Title: Spanish and Greek Responses to Debt Crisis Unleash Backlash from Citizens Run Time: 6:48 Abstract: This video explores the new protests against proposed austerity measures in Greece, a country that has seen significant turmoil in recent months because of its high level of debt, and then considers the deteriorating situation in Spain, and the potential that it could also need bailout funds from the European Union and/or the International Monetary Fund.

Key Concepts: European Union, euro, globalization, political economy, political risk, economic integration, economic risk, global economy, International Monetary Fund (IMF) Notes: New protests broke out in Greece last week as Greek officials contemplated implementing new austerity measures. The protests, which turned violent at times, came after a period of several weeks of relative quiet. Protesters fear that the proposed reforms could be the straw that breaks the camel’s back. According to Jacob Kirkegaard of the Peterson Institute for International Economics, last week’s protests were actually a 9-13 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 09 - Regional Economic Integration

carefully crafted response by Greek labor unions to government officials who are negotiating with the International Monetary Fund (IMF) and European Union (EU) for financial assistance. The labor unions hope to attract attention to their plight, and raise awareness of just how painful additional austerity measures would be. However, with a cumulative drop in GDP of some 20 percent, government officials appear to have few alternatives.

Another European Union member, Spain, is also experiencing its share of unrest as it becomes increasingly apparent that it too will probably need bailout from the European Union and/or International Monetary Fund. Spain will be announcing its budget for the upcoming year shortly, and some have suggested that the country is hoping to preemptively announce reforms before the European Union can actually mandate them as part of an assistance program. Jacob Kirkegaard believes that political moral hazard may be playing a role in situation. He notes that it is in the best interests of the European Union to discourage other countries from requesting similar financial assistance.

The situation in both countries has highlighted the political instability plaguing not only Spain and Greece but the European Union in general. In Greece, despite assurances from parliamentarians like Kyriakos Mitsotakis that there will be no further austerity measures, there is concern that the resistance to the proposed reforms could result in government officials being voted out of office. In addition, unease about the high number of unemployed youths and the potential for a lost generation are contributing to further unrest in both Spain and Greece. For now, given that there is no quick and painless solution to the debt problems in both countries, discontent and turmoil is likely to continue.

Discussion Questions and Answers: 1. What is the European Union? How do debt problems in Greece and Spain affect the European Union as a whole and its member countries? What are the potential political implications of the austerity measures being currently being proposed in Greece and Spain?

Answer: The European Union is comprised of 27 countries. The agreement eliminates tariffs among member countries, establishes a common policy toward nonmembers, allows for the free movement of people and capital, and harmonizes fiscal and monetary policies. Most members have adopted the bloc’s common currency, the euro. Because of the economic integration implied by membership in the European Union, economic and political problems in one member country can spill over into other member countries. In addition, instability in one or a few member countries can destabilize the bloc as a whole.

Most students will probably recognize that it is clear that there is little common support for the austerity measures Greece, and now Spain, are proposing. Citizens in both countries have voiced their opinions through protests. Many students may suggest that angry voters are likely to voice their opinions at the polls as well. Students will probably conclude that this creates an untenable situation - one where changes is inevitable, and the future is unknown.

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Chapter 09 - Regional Economic Integration

2. Consider the opposition to further austerity programs in Greece. Labor unions claim that they cannot endure any further cuts to their wages or pensions. In your opinion, are they being short sighted? Do you think additional cuts could help the country recover from its recession and debt burden? What role does the European Union play in the proposed reforms?

Answer: The violent protests in front of the Greek parliament building by 6,000 laborers last week were just one more indication of the high level of frustration of Greek workers.

Labor unions were hoping to not only draw attention to their plight, but also stop a new set of austerity measures from going into effect. The proposed new measures would cut already reduced wages and pensions by up to another 30 percent. Most students will probably suggest that while they can sympathize with the workers, government officials probably have in fact, very little choice to do anything else. Continuing on the path of taking on further debt is not a viable alternative. Indeed, many students will probably suggest that the real question should be just how deep the latest round of reforms needs to be. Other students however, may wonder whether the country is trying to clean up its mess too quickly. Students taking this approach may point out that it took the country years to get into debt, and it could take years to recover. Students may wonder whether the European Union should focus on ensuring political and economic stability as its primary goal.

3. Discuss the notion of political moral hazard and why it is a concern in the European Union.

Answer: Germany, along with other members of the European Union is approaching the bailout of Greece with a great deal of trepidation. There is considerable concern that if a debt relief package is awarded to Greece, there will be a general expectation that other member countries should be entitled to similar assistance. In other words, a decision to provide relief to Greece essentially means that Spain could be next in line, along with Portugal, and so on. To avoid this, the European Union is making it very difficult for Greece to get a bailout by demanding that the country implement unpopular austerity measures. The hope is that if the path to get a bailout is not easy, other countries may be dissuaded from even trying.

4. Reflect on the long term implications of high unemployment among the younger generations in Spain and Greece. In your opinion, does membership in the European Union increase the chance for brain drain?

Answer: Unemployment levels have reached extraordinary highs in both Greece and Spain. The problem is particularly bad for the younger generation raising concerns for the potential for a lost generation. Indeed, estimates put the unemployment rate at about 25 percent in Athens, and as high as a staggering 50 percent in Spain. Students may suggest that youths in these countries will have no choice but to leave their homelands to seek employment elsewhere within the European Union, which allows for the free movement of people, or even outside the bloc. However, students may also note that if 9-15 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 09 - Regional Economic Integration

this happens, the countries’ “best and brightest” may be lost forever, a situation that could have a negative long term impact on the Spain and Greece’s ability to successfully grow in the future.

INTEGRATING VIDEOS There are also several longer video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following from International Business DVD Volume 6:

Title: Twitter and Haiti Learning Objectives The purpose of this video is to help you: ❖ Understand how social media platforms are increasing the pace of globalization. ❖ Examine how new methods of communication are replacing more traditional ones. ❖ Recognize the marketing implications of how people communicate via social media. ❖ Explore how social media platforms may be changing social activism.

Key Words ❖ Globalization ❖ Global economy ❖ Technological change ❖ Cultural change ❖ Levels of economic development

Synopsis When the earthquake hit Haiti last year, many people, both within the country and outside, immediately got on Twitter and Facebook to get information about what was happening, and to communicate with each other. This crisis was one of the first of its kind in that rather than using more traditional forms of communication like the telephone or television, large numbers of people turned to new forms of technology like Twitter and Facebook. Even news reporters were scanning postings to learn more about the crisis.

This may reflect a global trend in which social media platforms are replacing long established means of communication.

After the earthquake, many people posted messages to family members indicating that they had survived and providing information about other friends and families. Some people also provided details about what had occurred and what they had seen. Some postings included information about problems that would probably occur as a result of the earthquake such as shortages of medical supplies and water. People outside Haiti were able to learn from these accounts of the extent of the devastation, and get a feel for what was ahead for the Haitian people and the country as a whole.

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Chapter 09 - Regional Economic Integration

Twitter and Facebook were also the first choice for many social activists and global health organizations involved with the crisis. Social activists were able to leverage the power of the social media platforms to reach out to people for help. Wyclef Jean, a popular Haitian musician, asked his 1.3 million Twitter followers to donate money to help for example. Interestingly, the efforts of activists like Jean were made easier because of the availability of social media platforms and cell phones. People could respond to their requests simply by sending a text message indicating their willingness to donate money. Global organizations like the Red Cross were also able to use social media platforms to raise awareness of the needs of the Haitian people and to organize contributions.

Discussion Questions 1. Discuss how new technologies emerged as a preferred form of communication after the earthquake in Haiti. What conclusions might a company targeting consumers in a developing country like Haiti draw from this phenomenon?

2. What challenges do social network platforms like Twitter and Facebook face in developing countries? Why might first mover advantages be important in these markets?

3. Reflect on the differences in how people use social networking platforms based on their geographic location. How can companies capitalize on the growing use of social media networks in developing countries and emerging markets?

4. Discuss how social media platforms are changing the way social activists raise awareness and gain support for their causes. How can companies that support social causes leverage these same opportunities?

INCORPORATING globalEDGE™ EXERCISES Use the globalEDGE™ site {globaledge.msu.edu} to complete the following exercises:

Exercise 1 The World Trade Organization maintains a database of regional trade agreements. You can search this database to identify all agreements that a specific country participates in.

Search the database to identify the trade agreements that Japan currently participates in.

What patterns do you see? Which region(s) of the world does Japan seem to be focusing on its trade endeavors?

Exercise 1 Answer Search phrase: Regional Trade Agreements Resource Name: World Trade Organization: Regional Trade Agreements Website: http://www.wto.org/english/tratop_e/region_e/region_e.htm globalEDGE Category: Regional Trade Agreements 9-17 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 09 - Regional Economic Integration

Additional Info: The Regional Trade Agreements page of the WTO provides a lot of background and analysis on RTA’s around the world. To access individual agreements, one has to enter the “RTA Database” following a link on this page. You can also access Maps of RTAs

by Country to see the agreements for each country.

Exercise 2 Your company has assigned you with the task of investigating the various trade blocs in Africa to see if your company can benefit from these trade agreements while expanding into African markets. The first trade bloc you come across is COMESA. Prepare a short executive summary for your company, explaining the level of integration the bloc has currently achieved, the level it aspires to accomplish, and the relationships it has with other African trade blocs.

Exercise 2 Search phrase: COMESA Resource Name: COMESA: Introduction Website: http://globaledge.msu.edu/trade-blocs/comesa/ globalEDGE Category: Trade Blocs: COMESA Additional Info: The Common Market for Eastern and Southern Africa (COMESA) is a free trade area that encompasses 19 countries stretching from Libya to Zimbabwe. The Trade Blocs section of globalEDGE provides information on the history and objectives of the trade bloc, as well as its member states.

End of Part Case Notes Part Three Legal Outsourcing 1. What are the benefits to a law firm of outsourcing of legal services to a foreign country? What are the potential costs and risks?

Answer: Outsourcing routine legal tasks to foreign law firms helps keep costs down and helps companies and law firms improve their efficiency and minimize their business and legal risks.

2. What kind of legal services are most amenable to outsourcing?

Answer: Many legal tasks are routine and are easy to outsource. These include reviewing documents and drafting contracts.

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Chapter 09 - Regional Economic Integration

3. Which groups gain from the outsourcing of legal services? Which groups lose?

Answer: Lawyers in foreign countries such as India stand to gain from outsourced legal work. Lawyers who are recent graduates typically do “grunt” work at U.S. law firms.

With this type of work going overseas, new lawyers in the United States may have a difficult time getting hired.

4. On balance, do you think that this kind of outsourcing is a good thing or a bad thing?

What are the risks here?

Answer: Students’ answers will vary. From a client standpoint, sending “routine” legal work overseas may help contain clients’ costs. From a legal standpoint, law firms need to be careful determining what type of work can be done by overseas legal services.

5. Why were the services in this case outsourced to India, as opposed to another country such as China? What does this case tell you about the kinds of factors that are important when a firm is considering whether to outsource a value creation activity, and where to outsource it to?

Answer: India is favored because local universities produce a steady stream of lawyers trained in common law, which is the legal tradition India inherited from the British. The same tradition underlies American law. Also, educated Indians speak English well, and the 10- to 12-hour time difference between India and the United States means that work can be done overnight in India, increasing responsiveness to clients.

The Global Financial Crisis and Protectionism 1. Why do you think calls for protectionism are greater during share economic contractions than during boom periods?

Answer: Sharp economic contractions are of course directly linked to slowdowns in

demand forcing companies to adopt new strategies. One such strategy may be to lobby for protection from imports. Another action may be to lay off workers. In an effort to protect their jobs, unionized workers may also lobby their governments for protection from foreign competition.

2. Despite the sharp economic contraction during 2008–2009, the increase in protectionist measures was fairly modest. Why do you think this was the case?

Answer: Thanks to the greater number of trade agreements in place today as well as WTO rules, many countries found they had limited options when they tried to respond to the recent global recession. In the past, countries had more freedom to implement protectionist policies like tariffs designed to help domestic companies remain competitive 9-19 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 09 - Regional Economic Integration

and protect domestic jobs. Now however, countries must be more creative with their efforts or risk violating trade agreements. During the recent economic slump, some countries focused on bureaucratic changes that effectively limited imports while other countries provided subsidies to give domestic companies a competitive edge over global competitors.

3. During 2008–2009, many developed nations gave subsidies to their automobile producers. How might this have distorted international trade? Was this a reasonable thing to do given the circumstances?

Answer: The 2008-2009 financial crisis prompted many countries including the United

States to provide subsidies to automakers. While the assistance helped companies remain in business and protected jobs, it also created an artificial environment for them and may have prompted some companies to shift production from more efficient locations to less efficient plants in order to qualify for greater subsidies. Students may be divided on whether the subsidies were beneficial. Some students will probably point out that the subsidies helped companies preserve jobs and in doing so, introduced a level of stability during a very precarious time. Other students however, may wonder what will happen when the subsidies end and whether in fact the policies simply prolonged the hard decisions that must ultimately be made.

4. What might occur if renewed economic slowdown triggered a wave of protectionist measures around the world? Would protectionism protect jobs, or would it make things worse?

Answer: In mid-2011, the global economy was still unstable, and the threat of a double-

dip recession was very real. Many students will probably suggest that if the economy fails to fully recover, many companies will continue to face low demand and because of the protection they received in the past, may still be unprepared to deal with it and once again lobby for further protection. However, some students may point out that many governments are now facing their own financial challenges and may be less willing to help. Other students may wonder whether governments may focus on bureaucratic policies as a means of helping companies in the future rather than on subsidies. In the end, most students will probably agree that while protectionist measures can protect jobs in the short-run, companies must ultimately become more efficient, and countries must support industries that will be sustainable in the long-run.

5. The volume of world trade rebounded sharply in 2010 on the back of a fairly modest

growth rate in the world economy. What does this tell you about the nature of international production in today’s global economy? What does this tell you about the vulnerability of the world economy to any future trade wars?

Answer: Most students will probably recognize that today’s economy is truly global in

nature. A modest increase in demand can result in a substantial increase in the volume of world trade thanks to the global nature of production where parts for products may come 9-20 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 09 - Regional Economic Integration

from a number of countries and assembly may take place anywhere in the world.

Students should recognize that because global production is now the norm in so many industries, the world economy is far more vulnerable to future trade wars than it was in the past.

NAFTA and Mexican Trucking 1. What are the potential economic benefits of the trucking provisions in the NAFTA treaty? Who benefits? Who might lose?

Answer: Under the NAFTA agreement trucks from Mexico are no longer required to unload their goods and reload them onto U.S. trucks. Instead, Mexican trucks can simply cross the border and continue to their final destination. These changes save time and also money – efficiencies that can then be passed along to consumers. In addition, because U.S. truckers must now compete with Mexican truckers, further savings should be created. Most students will probably suggest that if the NAFTA agreement is followed, U.S. consumers should benefit as should Mexican truckers. The real losers appear to be U.S. truckers. Most students will probably recognize that this situation accounts for the strong stance the Teamsters have taken against the agreement.

2. What do you think motivated the Teamsters to object to the trucking provisions in NAFTA? Are these objections fair? Why did Congress initially align itself with the Teamsters?

Answer: The Teamsters have rigorously objected to the provisions of NAFTA allowing Mexican truckers to cross U.S. borders and deliver their goods to their destination. Prior to NAFTA, Mexican trucks were required to reload their goods onto U.S. trucks at the border. The Teamsters are worried not only about the loss of this business, but also the new competition that the Mexican truckers will introduce. Many students will probably realize the challenges faced by the Teamsters and may sympathize with them, but will ultimately probably agree that the bloc as a whole is better off if the provisions outlined in NAFTA are upheld. Students may suggest that it is only because of the union’s power that the United States delayed implementing the agreement.

3. Does it make economic sense for the United States to bear the costs of punitive tariffs as allowed for under NAFTA, as opposed to letting Mexican trucks enter the United States?

Answer: When the United States initially failed to abide by provisions set forth in NAFTA regarding trucks, Mexico gave the country a second chance to honor its commitment. The United States responded with bureaucratic measures designed to block Mexican trucks from entering the country. Mexico immediately implemented new tariff policies on various U.S. goods destined for Mexico. Under the new policies, grape exporters faced 45 percent tariffs and other U.S. exporters faced 20 percent tariffs. Most students will probably agree that Mexico’s response was justified and suggest that the effort by the United States to protect the Teamsters simply hurt another group of 9-21 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 09 - Regional Economic Integration

Americans. Students may also note that U.S. consumers and companies should benefit from the efficiencies that the agreement should provide, and that the efforts to protect a single group are misguided.

4. Why do you think the Obama administration brokered a deal with Mexico to allow Mexican truck drivers to access the United States? Do you think this is a reasonable deal?

Answer: Under NAFTA, Mexico has the right to place tariffs on goods shipped from the United States to Mexico. California was hit hard by these tariffs because it exports a large amount of agricultural products to Mexico, along with products from other U.S. states.

To alleviate the tariffs, the administration signed an agreement to allow Mexican truck drivers access to the United States, which helped both countries.

The Rise of the Indian Automobile Industry 1. What are the attractions of India as a base for producing automobiles for domestic sale,

and for export to other nations?

Answer: From 2003 to 2008, India’s exports of automobiles jumped five fold. South Korean automaker Hyundai led the way exporting more than one third of its Indian production. Now, other companies including BMW, Nissan, Ford, and Toyota are following Hyundai’s lead. The companies are attracted by India’s low cost, highly productive labor force that has the ability to produce high quality vehicles. In addition, India has a large number of engineers who are able to “think outside of the box” and develop models for both the burgeoning Indian market as well as for export markets.

2. Both Hyundai and Nissan made their investments in the southern Indian city if Chennai. Is there an advantage to be had by investing in the same region as rivals? What is it?

Answer: Nissan’s decision to invest in the same city as Hyundai was probably driven by the support structure that Hyundai’s investment helped to create. When Hyundai initially built its operations it had to start from scratch, training employees, establishing a supplier network, and so on. By investing in Chennai, Nissan will be able to take advantage of Hyundai’s efforts. Moreover, it is likely that engineers and suppliers will continue to be attracted to the region making it even stronger in the future. Some students may liken the process to that which occurred in Silicon Valley when suppliers, researchers, engineers, and so on helped to establish the region as a dominant force in the computer industry.

3. What are the drawbacks of basing manufacturing in a country like India? What other locations might be attractive?

Answer: One of the major challenges facing companies in India is its inadequate infrastructure. Roads are poor and overcrowded making it difficult for companies to implement the just-in-time system that is common for most automobile manufacturers.

In addition, local suppliers are still hard to find and those that are available may not offer 9-22 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 09 - Regional Economic Integration

the quality levels companies demand. Students may suggest that companies could avoid some of these problems by locating production where the infrastructure is better developed, however, they may also note that doing so could also mean higher costs.

4. If Hyundai, Nissan, their suppliers, and other automobile companies continue to make investments in the Chennai region of India, how might this region evolve over time?

What does this suggest about manufacturing location strategy?

Answer: It has been suggested that over time, India’s Chennai region could develop into a mini Detroit where most global auto companies have a presence and where the supplier network and other supporting industries are well-established. Most students should recognize the importance of country factors in the choice of production location and that these factors can change over time. Consequently, it is imperative that companies continually reassess their manufacturing strategy.

Logitech 1. In a world without trade, what would happen to the costs that American consumers would have to pay for Logitech’s products?

Answer: Logitech moved its manufacturing to Taiwan and China in an effort to save money and maintain a competitive advantage. While labor costs were a factor in the decision to shift its manufacturing, other costs were also considered. The case notes that Taiwan offered a well-developed supply base for parts, qualified people, and a rapidly developing local computer industry. In addition, the company was able to secure space for only $200,000. In China, Logitech is able to employ workers for just $75 per day. If Logitech were not able to take advantage of opportunities such as these, and export its product back to the United States, American consumers would pay significantly higher prices for the company’s products.

2. Explain how trade lowers the costs of making computer peripherals such as mice and keyboards?

Answer: The theories of Smith, Ricardo, and Hecksher-Ohlin show why it is beneficial for a country to engage in international trade even for products it is able to produce for itself. International trade allows a country to specialize in the manufacture and export of products that can be produced most efficiently in that country, while importing products that can be produced more efficiently in other countries.

3. Use the theory of comparative advantage to explain the way in which Logitech has configured its global operations. Why does the company manufacture in China and Taiwan, undertake basic R&D in California and Switzerland, design products in Ireland, and coordinate marketing and operations from California?

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Chapter 09 - Regional Economic Integration

Answer: The theory of comparative advantage suggests that it makes sense for a country to specialize in producing those goods that it can produce most efficiently, while buying goods that it can produce relatively less efficiently from other countries—even if that means buying goods from other countries that it could produce more efficiently itself.

Logitech has successfully located the various parts of its value added chain around the world to take advantage of those attributes that are available in each of the locations in which it operates.

4. Who creates more value for Logitech, the 650 people it employs in Fremont and Switzerland, or the 4,000 employees at its Chinese factory? What are the implications of this observation for the argument that free trade is beneficial?

Answer: Logitech has taken great care in configuring its global value chain to lower production costs while maintaining the value of those assets that lead to differentiation.

Logitech undertakes basic R&D work in Switzerland, and also in Fremont. Fremont is also the location for the company’s global marketing, finance, and logistics operations.

Clearly, Logitech is successfully exploiting the benefits of the American and Swiss labor force, while at the same time taking advantage of the lower costs of production available in China. Logitech’s operations support the argument that free trade is beneficial.

5. Why do you think the company decided to shift its corporate headquarters from Switzerland to Fremont?

Answer: Switzerland is still important to Logitech. Indeed the company undertakes basic R&D work there. However, in an effort to be closer to many of America’s hightechnology enterprises, Logitech moved its headquarters to Freemont, California.

Freemont is now home to the company’s global marketing, finance, and logistics functions, and is also the location for some additional R&D work.

6. To what extent can Porter’s diamond help explain the choice of Taiwan as a major manufacturing site for Logitech?

Answer: According to Porter, four broad attributes of a nation shape the environment in which local firms compete, and these attributes promote or impede the creation of competitive advantage. The four attributes are factor endowments, demand conditions, related and supporting industries, and firm strategy, structure, and rivalry. The first attribute, factor endowments, clearly helps explain the choice of Taiwan as a major manufacturing site for Logitech. Taiwan has a well-developed supply base for parts, as well as qualified people. In addition, Taiwan’s rapidly expanding local computer industry (related and supporting industries) also puts the country in a strong position to be a major manufacturing site for Logitech.

7. Why do you think China is now a favored location for so much high-technology manufacturing activity? How will China’s increasing involvement in global trade help that country? How will it help the world’s developed economies? What potential problems are associated with moving work to China?

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Chapter 09 - Regional Economic Integration

Answer: Foreign companies now account for three-quarters of China’s high tech exports.

Porter’s diamond would suggest that like Taiwan, China has strong factor endowments and strong related and supporting industries. Together, these attributes make China an attractive location of high-tech manufacturing. China’s increasing involvement in global trade should help the country by spurring its economic growth. This in turn, should create more demand for imports which should be beneficial to the world’s developed economies.

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