Business and the international economy
Contents: 7 sections
Globalisation and why it happened
Globalisation is the growth of business activity across national borders, so that a business buys, sells and produces in many countries instead of one. A shirt designed in one country, sewn in a second from cotton grown in a third and sold online to a customer in a fourth is globalisation in one product.
0264 names four reasons, and a question on why globalisation has increased wants these rather than a general story about the world getting smaller.
| Reason | Why it increases cross-border business |
|---|---|
| Improved transport links | Container ships, air freight and better ports make moving goods long distances cheap and reliable, so distant suppliers and markets become worth using |
| Technological change, including communication | The internet, video meetings and ecommerce let a business sell to customers and manage suppliers thousands of miles away without an office there |
| Free trade agreements | Countries agree to reduce tariffs and quotas between them, so exporting into a partner country becomes cheaper and simpler |
| Newly industrialised countries | Countries whose manufacturing has grown quickly are low-cost places to produce, and their rising incomes make them fast-growing markets to sell to |
For any one business it cuts both ways, which is what an 8-mark part is testing.
| Opportunities | Threats |
|---|---|
| A much larger market, so higher sales and economies of scale | Foreign competitors enter the home market, often at lower prices |
| Cheaper materials, components and labour from abroad | A long supply chain that strikes, weather or politics can break |
| Risk spread across economies, so a recession in one matters less | Exchange rate movements change costs and prices without warning |
Import tariffs and import quotas
Governments do not always want free trade, and the two main controls behave differently.
| Import tariff | Import quota | |
|---|---|---|
| What it is | A tax charged on goods coming into the country | A physical limit on the quantity of a good that may be imported |
| How it protects home producers | Imports become dearer, so home-produced goods look cheaper by comparison | Fewer imports are allowed in, so home producers keep more of the market |
| Effect on a business that imports | Costs rise, so it raises prices or accepts a smaller margin | It may be unable to buy the quantity it wants at any price, so it must find another supplier |
| Effect on a home producer | Demand switches towards it, so sales rise | The same, plus the certainty that imports have a ceiling |
| Effect on an exporter | If other countries retaliate, its goods become dearer abroad and export sales fall | Its exports may be blocked once the quota is filled |
The two-sided answer earns the marks: the same tariff that protects a home manufacturer raises the input costs of the home business importing its components. Decide which yours is before judging whether a tariff is good news.
Multinational companies
A multinational company (MNC) is a business with operations, such as factories or outlets, in more than one country. Selling abroad is exporting; producing abroad is what makes a business multinational.
Why a business becomes one. It reaches a far larger market. It produces close to its customers, cutting transport costs and delivery times, and where labour, land or materials are cheaper. Producing inside a market also gets it over any tariff or quota wall, since goods made in the country are not imports, and host governments often add grants to attract it.
| Advantages for the host country | Disadvantages for the host country |
|---|---|
| Jobs. Unemployment falls, incomes rise, and that spending supports local businesses | Increased competition. Local businesses lose customers to a larger rival with lower costs and may close |
| Exports. Output sold abroad improves the country's trade position and brings in foreign currency | Environmental damage. Large plants may pollute, and a government keen to attract investment may enforce the rules weakly |
| Increased choice. Consumers get products and prices not available before | Exploitation of natural resources. Minerals, timber or fish are extracted quickly and taken away, leaving less for future use |
| Investment. Factories, machinery and training bring in technology and skills that stay in the country | Repatriation of profits. Profit earned locally is sent back to the home country instead of being reinvested |
| Tax revenue for the government | Skilled and senior roles are often kept in the home country, so local jobs can be low paid |
Repatriation of profits is the term candidates most often lose a mark on. "They take the money" is not enough; say that profits go back to the country where the parent company is based, so the host country keeps less of the value created.
External costs and external benefits
A business deciding whether to open a plant counts its private costs: wages, materials, rent, machinery. It does not usually count what its decision costs everyone else.
External costs are the costs of a business decision that fall on other people and are not paid by the business. External benefits are the gains that fall on other people without them paying for them. Together with private costs they give the social cost, which is private cost plus external cost.
| Decision | External costs | External benefits |
|---|---|---|
| A new factory beside a town | Lorry traffic, congestion and noise for residents, air pollution, loss of open land | Jobs and wages spent in local shops, a road improved for the factory that everyone can use |
| A quarry opening | Dust and noise damaging the health of nearby households, heavy vehicles wearing out local roads | Local suppliers gain contracts, employees are trained in skills they keep |
This sits in the international topic because the largest external effects often come from decisions taken across borders, where the cost lands on a community in one country and the profit in another. The damage itself, and the laws controlling it, are 6.3; the question here is who pays. External costs matter to a business because they rarely stay external: governments tax them, regulators fine them, and planning permission is refused because of them.
Exchange rates
An exchange rate is the price of one currency in terms of another. Appreciation means the currency has risen in value, so one unit of it now buys more foreign currency. Depreciation means it has fallen.
| Appreciation (currency stronger) | Depreciation (currency weaker) | |
|---|---|---|
| An exporter | Its products cost foreign customers more, so it becomes less competitive abroad and export sales fall | Its products are cheaper abroad, so it becomes more competitive and export sales usually rise |
| An importer | Imported materials, components and finished goods cost less, so costs fall and the margin improves | Imported inputs cost more, so costs rise and either prices rise or the margin is squeezed |
| A business that does both | Cheaper inputs partly offset dearer exports, so the answer depends on which side is larger | Dearer inputs partly offset cheaper exports, with the same test |
0264 states that candidates will not be assessed on exchange rate calculations. What is assessed is the direction: which way price, costs and competitiveness move, and what the business does next.
The specimen Paper 1 asks candidates to outline two ways an appreciation might affect a named business when it exports its products, for 4 marks. An outline part pays 1 mark for the point and 1 for applying it to that business, and the mark scheme credits exports becoming more expensive, exports falling in number, and the business having to find new markets:
Its exports become more expensive. [k] Customers abroad now pay more for its garden furniture, so orders from its largest overseas buyer fall. [app]
It may have to look for new markets. [k] It could sell more at home or in countries whose currency has not moved against it, which takes time it did not plan for. [app]
Do not develop those into consequences. Development earns nothing extra in a 4-mark outline part, so spend that time on parts (c) and (d).
What a business does about it. Facing an appreciation, an exporter can hold its foreign price and accept a thinner margin, cut costs, buy inputs abroad while its own currency is strong, or look for new markets. Which is right depends on how much of its revenue comes from exports and how price sensitive its customers are, and saying so is the evaluation mark.
Common mistakes
- Defining globalisation as "countries trading with each other", which has always happened, instead of the growth in cross-border activity.
- Confusing a tariff with a quota. A tariff is a tax on imports, a quota is a limit on quantity.
- Saying a tariff is good for every business in the country, when businesses importing components pay more because of it.
- Calling a business an MNC because it exports. It must have operations in more than one country.
- Saying repatriation of profits means the business makes a profit, rather than sending profit back to its home country.
- Treating an external cost as any cost the business dislikes. It is a cost paid by someone else.
- Getting the exchange rate direction backwards. Appreciation makes exports dearer abroad and imports cheaper at home.
- Answering an exchange rate question about an exporter as though it were about an importer, without checking which the business is.
What the syllabus asks for on this topicSyllabus points
Syllabus points
- Give reasons for globalisation: improved transport links, technological change including communication, free trade agreements, newly industrialised countries.
- Explain the opportunities and threats of globalisation for businesses.
- Explain what import tariffs and import quotas are, and their effects on businesses.
- State the advantages to a business of becoming a multinational company.
- State the advantages for the country where a multinational is located, such as jobs, exports, increased choice and investment.
- State the disadvantages for that country, such as increased competition, environmental damage, exploitation of natural resources and repatriation of profits.
- Explain the external costs and external benefits of business decisions.
- Explain appreciation and depreciation of an exchange rate.
- Explain how changes in exchange rates affect businesses that import and export, through price, costs and competitiveness.
Related CIE 0264 Business topics
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