Tag Archives: international trade

Digital Globalization– New Era Of Global Flows: Changing Rules– Rise of Connectivity, Decline of Cross-Border Trade…

Globalization is the ever-increasing integration of– people, cultures, business interests, innovation, governments… But its a contentious issue with people on one side, arguing that globalization is changing the world for better– propagating a heightened level of economic growth, improving human rights, improving access to technology, goods and services… On other side, critics argue– its destroying indigenous cultures, increasing inequality, deteriorating interests of workers, diminishing sovereignty of countries, exploiting under-developed countries to further the interests of the few developed countries…

The world is in midst of a rise in protectionism– anti-trade policies are at highest point since 2008 financial crisis. According to Fabrizio Minei; in recent years, the amounts of money that are flowing across-borders has drastically decreased, which represents drastic shift from international commerce, with localized markets more dependent on domestic consumption for growth… There is a global trend towards– regionalism, with like-minded nations banding together in a club of traders, or mini-lateral groups operating as most favored-trading partners. According to Joshua Cooper Ramo; localism is on the rise– local banking, local production, local sourcing for food, restaurants… 

However others take different view; they say rather than signaling the death of globalization, the decline in traditional metrics signals birth of a new digital globalization– one that is re-balancing geopolitics with geoeconomics… To succeed in the digital era, companies need to think about globalization in a different way, using different metrics, devise new frameworks to develop winning strategies… According to Jeff Immelt; it’s time for bold pivot, developing  strategy that focus on localization… but localism combined within a global footprint…

In the article Digital Globalization by James Manyika writes: The conventional wisdom says globalization has stalled, but even though the global goods trade has flattened and cross-border capital flows have declined sharply since 2008, globalization as world connection is not in decline; rather it’s entering a new phase defined by soaring digital flows of data, information… Remarkably digital flows that were practically nonexistent just 15 years ago, now exert a larger impact on GDP growth than centuries-old trade in goods. And this shift makes it possible for many organizations to reach global markets with less capital-intensive business models… Although it too poses new risks and policy challenges as well…

The world is digitally connected more than ever and it has changed globalization in fundamental ways… The amount of cross-border bandwidth has grown 45 times larger since 2005, and it’s projected to increase by additional nine times over next five years… as digital flows of information, searches, communication, video, transactions, intra-company traffic continue to surge… In addition to streams of data, information, ideas… these digital flows enable movement of goods, services, finance, people… Virtually every type of cross-border transaction now has a digital component…

International trade was largely confined to developed nations and large multinational companies… Today a digital form of globalization has opened the door to developing nations, small companies, start-ups, billions of individuals… Tens of millions of small, midsize enterprises, worldwide have embraced the digital economy and developed global e-commerce markets… Approximately 12% of the global goods trade is conducted via digital e-commerce. Even the smallest enterprises are digital global via the internet; 86% of tech-based start-ups report some type of cross-border activity…

Even individuals use global digital platforms to– learn, find work, showcase talent, build personal networks… Over a billion people have international connections on social media, and over 500 million take part in some type of cross-border e-commerce. In this increasingly digital era of globalization, companies can better manage cross-border operations in– leaner, more efficient ways… Using digital platforms organizations can sell into growing global markets, while keeping virtual teams connected in real-time…

Researcher find that over a decade, all types of digital flows acting together have raised world GDP by 10.1% over what would have resulted in world without cross-border flows. This value amounted to about $7.8 trillion in 2014 alone with digital data flows accounting for about $2.8 trillion of this impact. These digital flows are key for growth, as they expose economies to– ideas, research, technologies, talent, best practices from around the world…

In the article New Era of Globalization by ING writes: Globalization is like a fault line on the world’s ideological map: Most people are either passionate supporters or violent opponents of globalization–there is virtually no middle ground. According to Mauro Guillen; globalization is not a feeble phenomenon, it’s changes how world works– it’s neither civilizing or destructive, it’s neither monolithic or inevitable… but it does requires open-mind to understand it. The world has under-gone historic developments in last few decades; internet, smartphones, social media, rise of China, emerging markets, fast cheap travel. But the notion that globalization is a uniting and unifying force that eliminates nations’ physical borders is diminishing…

However there are many tricky issues and popular disenchantment with the concept of globalization. There is need for new (different) approach on how globalization economic and political policy impact working people, e.g.; economic equality of opportunity for middle class workers, more responsive governance to empower individuals at the local levels… without sacrificing the benefits of globalization. According to Lael Brainard; globalization is not a choice; it’s a force– driven by logic of markets and technology. It’s not product or service but process– it transforms the way people work and live and the very map of the world: You can’t stop it but you can shape it…

 

To Tariff or Not To Tariff– The Balance is Shifting: Global Trade Conflict– Free Trade, Fair Trade, Balance Trade, No Trade…

One of the most debated issues in global trade is protectionism; use of tariff, non-tariff measures, currency manipulation… On one hand, most nations believe that certain amount of protectionism is necessary to protect their industries, jobs… On the other, protectionism also invites retaliation from trading partners, blocks free trade. Tariff is essentially a tax; it raises price of imported goods making them more expensive than similar domestic goods…

In most developed countries, average tariffs are less than 10% and often less than 5%… while in lesser-developed countries tariff rates are much higher; ranging from 10% to over 25%, and in Iran at about 28%… In U.S., about 96% of merchandise imports are industrial (non-agricultural) goods, with a weighted average tariff rate of 1.5%… One-half of all industrial goods entering the U. S. enter duty-free… However, tariffs are not the whole story, there are also ‘non-tariff’ measures that countries use to restrict trade…

According to Brent Radcliffe; countries use combination of tariff and non-tariff measures to regulate imports… the non-tariff trade barriers restrict trade through mechanisms, such as; quotas, subsidies, customs delays, technical barriers, other systems preventing or impeding trade... Classical economists like David Ricardo and Adam Smith suggest that since a nation is not a homogenized whole; that free trade, from a political standpoint, actually creates two classes; beneficiaries and victims, i.e.; winners and losers…

In the article Free Trade vs. Protectionism by George Friedman writes: The question of free trade is a pivotal issue and one that transcends ideology… The idea that free trade (trade without tariffs, regulation) is better than protectionism has dominated since WWII… An argument for free trade was made by David Ricardo in early 19th Century– It was based on the theory of comparative advantages… It assumed that every nation has at least one industry in which it has an advantage over other nation;. and with focus on its industry it would maximize the nation’s income…

However, there is no simple solution to the free (non-free) trade debate; each side views trade based on its own interests. Each side shapes the economic landscape for its own benefits… The argument that there is an overall free trade benefit has little value, e.g.; a CEO would oppose a shift in trade policy if it hurt his business, no matter the national good… Also, individuals take the same stand…

In the article Currency Manipulation And Impact On Free Trade by Art Laffer writes: A prosperous economy is created by good economic policy– then just get-out-of-the-way and let companies and citizens work, produce, invest… The perfect pro-growth agenda includes: a low rate tax, spending restraint, sound money, minimal regulation, free trade. The gains from trade come from– differences between countries, not similarities– and greater the differences the larger the potential gains… When a country is not constrained in making products and services to only match domestic demand, then both consumers and producers win…

This is an idea that goes back to Adam Smith, one of the earliest advocates for free, unrestricted trade. As such, Smith was an ardent foe of mercantilism, a system under which the goal of a state was to stockpile gold by exporting as many goods as possible and importing as little as possible… Smith argued that this policy deprived nations of benefiting from skills and abilities found in other nations. Instead he argued, nations benefit better from free and open, not managed, trade.  All nations have unique set of skills and resources that enable them to produce certain goods/services better than others, which is the foundation of trade– taking advantage of unique skill, capabilities, resources…

Smith’s core beliefs remain true but, due to the complexity of today’s interconnected global world, sometimes it creates challenges for a market-based approach; for example, currency manipulation– it’s a potent tool that tempts nations to improve their trade balances, while exporting domestic unemployment to countries that do not manipulate their currencies… According to Peterson Institute for International Economics; more than 20 nations have used currency manipulation policies to keep currencies substantially undervalued, thus boosting their international competitiveness and trade advantage…

In the article Free Trade, Fair Trade, Race to the Bottom by Madeline Madison writes: The free movement of global resources, especially labor… presents serious issues that can potentially devastate not only an economy, but the environment as well– it’s the ‘race to the bottom’ theory, which states; companies are constantly searching for– cheaper wages, lower taxes, weaker environmental regulations… and the theory is that this can produce downward spiral in socio-economic conditions in countries around the world…

A basic view of this theory is that when there are no regulations on trade and no regulatory standards, companies move from country-to-country searching for cheaper resources with less environmental regulations… and over-time this quest for cost-cutting will devastate the economies and the environment of many countries around the world… However, this phenomenon can only occur in the absence of strong trade regulations and restriction on the actions that companies can legally take to lower operating costs… ‘Races to the bottom’ can also occur between administrative regions within nations…

In its early stages a ‘race to the bottom’ can appear to be beneficial to the parties involved as one country sees the benefit of lowered costs and others sees benefit of increased foreign investment… However, the competitive process involved in ‘race to the bottom’ can serves to undermine the ability of governments to improve living and working conditions… and the enforcement of humane labor standards, and funding for social services… The main way to avoid ‘race to the bottom’ is through a policy of ‘fair trade’ with strong regulations and controls that protect an economy and encourage global trade…

Economists say that ‘free trade’ allows countries to take advantage of the ‘comparative advantages’ offered by each country… The ‘comparative advantage’ exists when one country can do something better than another country, e.g.; Central and South America grows bananas better than U.S., and U.S. grows wheat better than them; so trading wheat for bananas makes sense… But, economists also say that low-labor costs and low-environmental protection costs are a ‘comparative advantage’, as well…

They say it’s good for companies to take advantage of countries with governments that exploit labor and the environment, because they offer lower-costs for making things… According to Dave Johnson; buying goods from countries that are low-wage, low-environmental protection means other countries are impacted with trade imbalance; hence, factories close, people laid-off, wages stagnate… In world of free trade– this is a ‘comparative disadvantage’…

Ease of Doing Business Index– Ranking Countries: More Transparency or Misleading… Keep It, Change It, Scrap it…

World Bank’s Ease of Doing Business Index (Index) measures the business regulations of countries, worldwide, and examines the key factors that directly affect each country’s businesses, for example; business formation, operation, laws, challenges… The concept behind the Index is simply– the daily economic activity of countries is shaped by the laws, regulations and institutional arrangements put in place by governments and institutions.

The Index examines and ranks the country’s business cycle; starting with the number of bureaucratic and legal steps required to start a business, or to register and transfer commercial property… It then delves into how long it takes and how much it costs to comply with regulations, such as; time and money needed to enforce contracts, file for bankruptcy, trade across borders… the Index measures levels of legal protection for investors and property, corporate tax rates, ease of closing a business, employment regulation…

The basic assertion of the Index is that smarter business regulation supports economic growth… simpler business registration promotes greater entrepreneurship and company productivity, while lower-cost registration improves employment opportunity… an effective regulatory environment boosts trade performance… sound financial market infrastructure, courts, creditor, insolvency laws… improves business access to credit… However, the Index does not directly measure the more general conditions, such as; a country’s proximity to large markets, quality of infrastructure, inflation, crime…

According to the World Bank; the Index is based on study of laws and regulations in countries worldwide with input and verification by more than 9,600 government officials, lawyers, consultants, accountants and other professionals in 185 countries who routinely advise-administer on legal-regulatory requirements. The Index averages a country’s percentile ranking on 10 topics, including: Starting a business: Dealing with construction permits: Getting electricity: Registering property: Getting credit: Protecting investors: Paying taxes: Trading across borders: Enforcing contracts: Resolving insolvency. Then, countries are ranked on their ease of doing business, from 1 – 185.

A high-ranking on the Index means the regulatory environment is more conducive to the starting and operation of a local business in country. In 2013 like in 2012, Singapore ranks first on the Index (seventh consecutive year it ranked first), followed by; Hong Kong, New Zealand, U.S., Denmark, Norway, UK, South Korea, Georgia (top 10 countries). Many sub-Saharan African countries and Venezuela are at the bottom of rankings.

According to the World Bank, its Index is having a significant impact on countries by identifying their business weaknesses, for example; 108 countries implemented 201 of its regulatory reforms in 2011/12, worldwide… 44% of these reforms focused on three areas, specifically; making it easier to start a new business, increasing the efficiency of tax administration, and facilitating trade across international borders. To make the data comparable across the 185 countries, the Index uses a standardized business framework; 100% domestically owned, has start-up capital equivalent to 10 times income per capita, engages in general industrial or commercial activities, and employs between 10 and 50 people…

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In the article World Bank Urged to Scrap Index by Marjorie Olster writes: The World Bank set-up an Independent Review Panel (Panel) to review the Ease of Doing Business Index process and concluded; the main Index was open to misinterpretation and should be discontinued… It urged the World Bank to continue publishing the Report without the headline Index, and instead give only separate rankings for each individual indicator now aggregated into the main Index.

According to the Panel Report; the Index has the potential to be misinterpreted… and the main disagreement is whether the Index measures the correct indicators in the correct way. In other words, the debate was about whether a higher ranking implied that a country was on the right track for effective private-sector business development.  

The World Bank set up the Panel after the Index came in for some harsh criticism from a number of directions… China and India, which ranked 91 and 132, respectively, in the latest Index, were among the critics. The Panel said the key criticisms were that the structure and publication of the

Report focused attention primarily on the indicator rankings (i.e., Index) to the exclusion of the Report’s remaining content. It said another big concern was whether the information being gathered was really relevant…

In the article World Bank Keeps Index Despite Criticism by Reuters writes: The World Bank said that it intends to keep ranking nations (i.e., Index) on the ease of conducting business, despite criticism from countries like China that feel the scorecard unfairly stigmatizes fast-growing developing countries. According to World Bank President Jim Yong Kim; the Bank is committed to keeping its flagship Report, including the Index, which compares the ease of starting and conducting a business in 185 countries…

The Report is prepared by the Bank and its private-sector lending arm, the International Finance Corporation. It has become one of the Bank’s most popular publications, since it began its publication in 2003. Smaller developing countries often use the Report to show outside investors how much they’ve improved their business environment. Government officials may use it as an incentive to promote business-friendly legal changes, such as, eliminating red tape.

The U. S., which is ranked number four, supports the Report and its Index… Others have criticized the Report’s methodology and said it has a bias against all regulations, including; protections for workers. According to several sources, China pushed especially hard for modifying the Report and getting rid of the Index system; arguing the World Bank should not rank its members. China was ranked number 91, in 2013 Report… prompting suspicions that its opposition was motivated by the low ranking…

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In the article Widespread Corruption in Businesses by Mitchell Ogisi writes: Corruption in business is an issue for developed and developing countries, however, developing countries may suffer more because corruption can stymie business development and foreign investments and foster income inequality. Apparently this is the case in many developing countries’ lower rankings on the World Bank’s Ease of Doing Business Index, which gauges how conducive a country’s business environment is to starting and operating a local business…

In some world regions, results can vary widely across local countries and particularly countries at different stages of economic development. In Asia, for example, a relatively low 13% of residents in highly developed Singapore perceive corruption as widespread in their businesses– Singapore ranks first on the World Bank’s Ease of

Doing Business Index. In contrast, nearly nine in 10 adults in neighboring Indonesia perceive corruption as widespread in their businesses– Indonesia Ease of Doing Business Index ranking is 129. Perceptions of business corruption also vary widely in former Soviet countries, ranging from low of 28% in Georgia to high of 87% in Moldova.

Georgians’ perceived corruption in their businesses has dropped precipitously since 2006, when more than half the population (52%) viewed the problem as widespread. This decline and Georgia Ease of Doing Business Index ranking of 16, worldwide, likely reflect some dividends from its efforts to eradicate corruption with a zero-tolerance, anti-corruption campaign…

But it’s also important to note that high perceived corruption does not always translate into lower Ease of Doing Business Index ranking, particularly in developed countries with higher GDPs. Paradoxically, higher perceptions of corruption in some wealthier countries may reflect greater transparency, and therefore greater awareness among the population of corrupt practices. For example, 85% of Israelis say corruption is widespread in their country’s businesses, and their Ease of Doing Business Index ranking is 34.

According to World Bank, corruption is one of the single largest obstacles to economic and social development. Corruption in business is important global concern that involves both, developing and developed countries. It can be difficult to accurately monitor corruption in business, particularly in countries with little or nonexistent transparency, making tracking their residents’ perceptions even more relevant. Strong leadership, policies, laws, and greater transparency are necessary to fight corruption, which in turn may actually promote job creation and economic development…

A fundamental premise for ease of doing business and strong economic activity is fair business regulation, which are transparent and accessible to all– not just big business. According to World Bank; a country’s business regulations should be efficient, striking a balance between safeguarding the important aspects of the business environment and avoiding distortions that impose unreasonable costs on businesses.

Where business regulation is burdensome and competition limited, success depends more on whom you know, than on what you can do. But where regulations are relatively easy to comply with and accessible, to all who need to use them, anyone with talent and a good idea should be able to start and grow a business, legally.

However, according to critics; a country’s rank on the Ease of Doing Business Index does not tell the complete story about a country’s business environment, and the underlying indicators do not account for all factors important to doing effective business, such as; macroeconomic conditions, market size, workforce skills, security… also, they do not examine the key aspects of business regulatory and institutional environment that really matter.

According to World Bank; the Index is very effective at promoting change for countries that wish to improve their rank on the Index, for example; the top 20 countries on the list have implemented effective changes by streamlined their business regulatory procedures, such as; ease of starting a business, dealing with construction permits, strong legal protections of property rights… They also, periodically review and update business regulations as part of a broader competitive agenda and take advantage of new technologies through government initiatives…

However, there are many critics that say; while the World Bank Index plays an important role in conveying new information relevant to monitoring aspects of the business climate on a timely and internationally comparable basis, there are many flaws associated with it… Key among these is the relevance of the information gathered, indicators being measured, spectrum of businesses being analyzed (e.g., currently only small and medium-sized enterprises), and basis of its comparability across countries with different needs and at differing stages of development…

International Trade– Models, Benefits, Risks: Global Economic Outlook, 2013… Open Markets Drive Trade Development…

International Trade: Countries cannot live in isolation. They must mutually share their resources, technical know-how, products and services, and undertake international trade in order to grow their economies and prosper…

The world economies are closely inter-dependent; economic progress of all nations depends on their ties with other countries… International trade is a vital engine for economic development, and in most countries it represents a significant share of their gross domestic product (GDP)…

According to Ben Bernanke: In U. S., as best we can measure, international trade is critically important. According to one study that used four approaches to measuring the gains from international trade, the increase in trade since World War II has boosted U.S. annual incomes on the order of $10,000 per household (research by Bradford, Grieco, and Hufbauer).

The same study found that removing all remaining barriers to trade (i.e., free trade) would raise U.S. incomes anywhere from $4,000 to $12,000 per household. Other research has found similar results. Our willingness to trade freely with the world is indeed an essential source of our prosperity– and I think it’s safe to say that the importance of trade for the U.S. will continue to grow…

While international trade has been present throughout much of history, its economic, social, and political importance has been on the rise in recent centuries… The classical model of international trade was developed over 200 years ago by Adam Smith. He believed that different countries possessed unique advantages in the production of certain goods. He then showed that world output would rise if countries traded freely along the lines of their productive advantages…

Torrens and Ricardo expanded on this theory by showing that even if a country did not have an absolute advantage in any goods, both it and other countries would still benefit from international trade. This would be the case if countries specialized in the production of goods with which they had the greatest absolute advantage, or the least absolute disadvantage– this is known as law of comparative advantage

Pre-trade relative prices, in many cases, determine the direction of comparative advantage and therefore the direction of trade… International trade is most commonly recognized as the exchange of goods or products; however, trading services such as, expertise in a particular field or the ability to facilitate the trade of goods is another common form of foreign trade.

Trading capital on the foreign exchange market (FOREX) represents a third facet of international trade. Capital or currency held for foreign trade fluctuates in value hourly due to political, business, weather and other conditions and factors from nation to nation. Trading currency in the international market attempts to profit from the rising value of one nation’s currency through selling the lower value of another nation’s capital…

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In the article Different Types of International Trade Models?  by Peter Hann writes: International trade models may be traced back at least to the theory of absolute advantage put forward by Adam Smith. This theory demonstrated that it was beneficial for a country to specialize and to engage in international trade if it could produce some goods more efficiently than its trading partners.

This theory was further developed by the comparative advantage theory of David Ricardo, which showed that a country should specialize in those goods in whose production it was comparatively efficient. Ricardo’s theory has been further refined in more recent times to produce neo-Ricardian theory that uses fewer assumptions than the original theory.

Other important international trade models include; the Heckscher-Ohlin theory that emphasizes the importance of factors of production in a country, and the gravity theory that looks at the size and proximity of trading partners. While Smith only demonstrated that international trade was beneficial in certain specific circumstances, Ricardo’s theory showed it always makes sense for a country to specialize in producing those goods and services in which it is comparatively most efficient. This specialization increases productivity and boosts the total output of the country.

A country does not need to have an absolute advantage in producing goods provided the opportunity cost of producing the goods is lower than that of its trading partners in producing same goods. Ricardo’s theory of comparative advantage uses numerous assumptions. For example, it assumes that the only input to industrial production is labor and that labor is mobile between industries, but not between countries.

Modern refinements to Ricardian theory have produced international trade models that can demonstrate comparative advantage across a range of goods and countries, rather than Ricardo’s original model that used two countries and two categories of goods. The Heckscher-Ohlin model of international trade emphasizes the resources available in each country and stresses the importance of factors of production in each country. The abundance of factors such as, labor or capital in a country determines the type of international trade the country engages in.

The country produces and exports goods that take advantage of the factors of production that are abundant, and will import those goods that require the input of factors of production that are scarce in the country. International trade models also include the gravity model that looks at the economic mass of each country and the distance between the trading partners. The gravity model arrives at a prediction of the trade flows between the countries based on these elements and other factors such as, the historical context between countries that have affected trading patterns…

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Global Economic Outlook 2013, May 2013 Update: According to the World Trade Organization (WTO); global commerce is set to grow by 3.3% in 2013, as persistent gloom in the EU led it to cut a previous forecast of 4.5%. The announcement marked the second time that the WTO has reined in its figures for 2013, after initially estimating that world trade would expand by 5.6%.

The WTO report said: In 2013, improved economic prospects for U. S. should only partly offset continued weakness in the EU, whose economy is expected to remain flat or even contract slightly according to consensus estimates; and, China’s growth should continue to outpace other leading economies, cushioning the slowdown, but exports will still be constrained by weak demand in the EU. As a result, this year looks set to be a near repeat of 2012, with both trade and output expanding slowly…

In 2012, the WTO said, global commerce expanded by 2.0% from the level in 2011, compared with growth of 5.2% that year. In 2012, the dollar value of world merchandise exports increased by 0.2% to $18.3 trillion… That trend was driven by falling prices for traded goods with commodities such as; coffee, cotton, iron ore and coal seeing major drops, while oil remained relatively stable. Meanwhile, the value of world commercial services exports rose by 2.0% to $4.3 trillion…

 In 2013, First Quarter Trade Results: Merchandise trade growth increased in major economies during the First Quarter of 2013. Compared to Fourth Quarter of 2012, value of merchandise imports and exports for the total of G7 and BRICS countries increased by 1.3% and 2.8%, respectively. Compared to the previous quarter, merchandise– imports and exports– increased in First Quarter of 2013 in most major economies, for example: Germany (by 3.9% and 4.8%), China (by 0.9% and 5.6%), Brazil (by 5.1% and 4.9%), U. S. (by 0.7% and 1.0%), Italy (by 1.4% and 3.2%), Canada (by 1.6% and 1.2%), France (by 0.5% and 1.9%), and Russian Federation (by 4.9% and 0.0%).

Conversely imports grew and exports contracted in South Africa (by 4.3% and minus 0.3%), while the opposite pattern (i.e. imports contracted and exports increased) held in UK (by minus 0.3% and 1.3%) and in India (by minus 0.9% and 6.1%). In Japan, imports contracted slightly in the First Quarter of 2013 (by minus 0.1%), whereas exports decreased more significantly (by minus 2.3%) for the fourth consecutive quarter…

Most countries of the world cannot have a growing economy or lift the wages and incomes of their citizens unless reach beyond their borders and sell products, services… to the world’s populations…  Exports support millions of jobs worldwide, for example; in U.S. more than 50 million workers are employed by companies that are engaged in global trade, and this represents approximately 40% of the U.S. private sector workforce…

Often overlooked is the fact that more than 97% of the quarter million U.S. companies that export are small and medium-sized enterprises (SMEs), and they account for nearly a third of U.S. merchandise exports… International investment is also critical to the future prospects of world business, for example; multinational corporations earn trillions of dollars in revenue through their foreign operations, which create tremendous value for stakeholders…

There are both benefits and pitfalls in international trade, and how these are managed determines the relative success of operations… Consider benefits: When trading internationally the universe of potential customers and suppliers increases significantly… The idea that a business relies solely on one market (e.g., home country) and directs all its resources into a single currency may prove to be more risky than it may first seem. Just look at the number of unprecedented global disasters over the last few years and the drastic impacts these have had on markets…

While expanding beyond home markets can increase sales, provide better profit margins, reduce pricing pressure, and could reduce seasonal market fluctuations… The ability to stand out from competitors is a crucial factor in business: In the home market your business may be viewed as comparable to competitors, but when placed in another country’s environment it may be considered a unique product or service not to be missed. By making the product or service available to worldwide buyers, you instantly create another life-line for the business… boost sales potential and allow your business to flourish…

However there are pitfalls, in international trade, and the key is managing risk… First and foremost, it’s crucial that you have a clear understanding of what international trade involves. It’s easy to become engulfed in the excitement of its benefits and marginalize risks… For example, it’s dangerous to assume that laws in countries are similar to those of the home country… and most critical is the development of meaningful relationships in the target countries…

With so many aspects to consider when trading at an international level, it’s easy to leave currency exchange to the last-minute, and it could have a negative impact on business’ profit, and if you do not plan ahead, the market’s volatility could always change the worth of the currency– and not always for the best…

International trade and investment is inevitable part of world economy, but international trade has to be approached sensibly and with a clear thought process so as to maximize the benefits and minimize the risks…

Shadow World of Economic–Offsets– An Anomaly in Business Practice: Cost to Compete for International Trade Agreements…

Offsets are ‘terms in a sale’ that leverages the sale to obtain compensatory benefits for the buyer, generally in many international trade arrangements… 

Offsets are an integral part of trade agreements between companies (i.e., suppliers) and governments (i.e., buyers); whereby suppliers must agree to buy products or provide other forms of commitment to the buying countries, in order to win the contract. 

Offsets are mechanisms to compensate typically, governments for outflow of their countries economic resource…

Their use is becoming increasingly important with more than 120 countries having international trade offsets policies… Even though the definition of ‘offsets’ is often disputed the main concept is simple: A country (buyer) that wishes to purchase and import, say, $100 Million worth of military arms from another country or company… and presumably the only economic value gained in return, for the purchase, is the putative national security-value of the imported arms.

Therefore, to increase the ‘economic exchange value’; the importing country (buyer) stipulates that the exporting country-company (seller) contractually must take a percentage (offsets) of the $100 Million purchase, and set-up a ‘flow-back’ to the buyer, e.g.; provide for co-production facilities in the buyers country, or commit to a variety of other possible activities that would secure the ‘flow-back’ percentage, of the $100 Million, to the importing country (buyer). This ‘flow-back’ or ‘offset’ is part of the trade contract… The importing country’s advertised benefit are; they obtain the necessary arms, plus the country’s public funds that are spent on the purchase remain in the country for use in other domestic activities, such as; stimulating the country’s economic development…

Countries use offsets for a variety of reasons, e.g.; ease the burden of large purchases on their economy, increase-preserve employment, obtain desired technology, promote industrial sectors… It’s interesting to note: Developed countries with established defense industries use offsets to channel work or technology to their domestic defense companies.

Countries with newly industrialized economies are utilizing both military and commercial related offsets that involve the transfer of technology and know-how… The developing countries with less industrialized economies generally pursue indirect offsets to help create profitable commercial businesses and build infrastructure. Overall, offsets continue to be an important and necessary factor in a climate of increased international competition…

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In the article Market Trends and Analysis of Offsets by Asif Khan writes: Offsets are industrial compensation practices that are required as a condition of purchase. The seller is required to compensate the buyer for perceived losses to the local economy. This practice has been part of international trade for more than fifty years… Offsets are also used in other industries, such as; power generation, telecommunications, infrastructure projects… For example, Pepsi signed an agreement with the Ukraine to expand its bottling plants and, in return, marketed approximately US$1 Billion worth of shipments of goods over an eight-year period… 

There are many who favor the practice of offsets, and there are many who oppose this practice. Some refer to offsets as kickbacks and as being counter to the free market approach, while others, especially some people in the defense industry, view offsets as a reasonable component of market practices and as a business development tool without which there would be no sales: The World Trade Organization (WTO) permits only civilian offsets (civil-civil) for developing countries only…

Offsets are now an accepted practice in the international business arena, and this is especially true in the defense industry. Many countries see offsets as a means of enhancing their local economies, and politically justifying spending on defense items and acquiring the latest technologies… Marketers should be aware of offset policies and practices of their foreign customers and governments to better prepare for the competitive bidding process. Defense firms should be aware of the trends in offsets and the demands of the respective markets, such as; local partnerships and production…

Three approaches are prominent when considering offsets policies: 1) policy adaptation requiring a mandatory offset component, 2) flexible case-by-case approach based on mutual benefits, and 3) best endeavor approach based on a partnership. Some countries start with one strategy, then after having some experience they might change the approach… Defense contracting firms have two options; engage in offsets or walk away from the deal... The defense industry views offsets as counter-balance for trade distortions imposed by government interventions… Also, as a tool for risk mitigation, access to capital, markets, technologies, and enhanced local workforce skills…

In response to a survey of U.S. defense firms conducted by the U.S. Commerce Department; 59% of respondents agreed with the concept that offsets are essential to win contracts, and based on the past transactions, offsets have proved to be a key decision criteria in international defense sales... Offsets exist in formal and informal forms: Some countries have adopted mandatory offsets, while others have adopted flexible offsets policies that focus on, e.g., long-term partnerships, dual-use technology, regional approaches…

Countries with skilled workforces, public-private enterprises, and developed international business relationships are better positioned to absorb the transfer of technologies than countries without these attributes. Based on the last fifteen years of U.S. export data, the overall trend shows that there has been a steady increase in the demand for offsets…

How Do Offsets Work? International offsets activities are directly related to the size of the international exports trading businesses: According to Stockholm International Peace Research Institute(SIPRI); the world’s 100 largest arms dealers, excluding China, sold weapons and military services worth US$411.1 Billion dollars in 2010… U.S. firms dominated the Top 100, with sales by 44 US-based companies accounting for over 60% of the market, or US$246.6 Billion…

Assume that the offsets on these export agreements might average about 90%, and then the U.S. exports of US$246.6 Billion would result in about US$222 Billion of future offset obligations, as the export contracts are fulfilled… Here is an example of a typical ‘offsets’ proposal: Consider a hypothetical case of ‘NationP’ (buyer) buying 300 tanks from defense company ‘CompanyS’ (seller).

Assume that the total contract is US$400 Million and NationP (buyer) requests 120% of offsets. Hence, the defense CompanyS (seller) is obliged to fulfill these offsets, if they want to win the contract. Then, NationP and ConpanyS agree on a list of specific offsets items, i.e., deals, programs… The offsets agreement includes both direct and indirect offsets. NationP also assigns a credit value for each typology of offsets offered by CompanyS.

The credit value for the offsets obligations is not the ‘actual value’ but it’s the ‘actual value by a multiplier’, which expresses the degree of interest of NationP in the proposed offsets. In other words, something that is deemed very valuable by NationP will have a high multiplier, which expresses the importance and the value to NationP for that type of offset. The multiplier (e.g., 2, 5, 7…) translates NationP‘s ‘attached value’ into the ‘credit value’, and that eventually accounts for the fulfillment of the agreed sum of US$480 (120% offsets).

Most offsets are divided into ‘direct’ and ‘indirect’: Here is a hypothetical proposal between CompanyS and NationP using both ‘direct’ and ‘indirect’ offsets:

Direct Offsets:

  • Co-production: NationP chooses one or more local companies to manufacture some components of the tanks, such as turrets and some of the internal components. The actual value of the components is US$70 Million. NationP assigns a multiplier of 3, since this develops capabilities of its military industrial base and creates jobs in NationP. The total credit value for the fulfillment of the overall offset obligation is US$70 Million x 3 = US$210 Million.

Indirect Offsets:

  • Foreign Direct Investments: CompanyS makes investments in 5 (defense or non-defense) companies in NationP. The total value of investments is US$14.5 Million, and the multiplier is 4, a high multiplier, since NationP suffers from a chronic lack of ‘Foreign Direct Investments’. This makes an additional credit value for CompanyS of US$58 Million.
  • Technology Transfer: CompanyS provides water desalination technologies to one NationP company. This technology is particularly appreciated by NationP. Its actual value is US$20 Million, but the credit value is 7 times the actual value, which equals US$140 Million.
  • Export Assistance and Marketing: CompanyS provides commercial assistance to market products and services of a NationP’s company in a difficult market… The assistance is offered for 8 years, at the value of US$3 Million per year. NationP considers this assistance important to create new revenue streams and jobs for its company, and sets multiplier of 3. Credit Value US$72 Million. CompanyS may not be  expert on marketing and export assistance, so it may hire a subcontractor for the job. Such a subcontractor is also known as an ‘offset fulfiller’.

In these agreements, NationP controls-manages not only the supply of the deliverables, but also the implementation of the offsets according to the offset agreement, included or related to the main supply contract. This control is within the Minister of Defense and/or Ministry of Economy or Finance, or Ministry of Industry and Trade. Often arms importing nations establish special agencies for the supervision of their defense offsets…

Welcome to the murky world of ‘offsets’… The practice came of age in the 1950s, when Dwight Eisenhower forced West Germany to buy U.S.-made defense gear to compensate for the costs of stationing troops in Europe. Since then it has grown steadily and is now accepted practice in 120 countries…

According to the Global Offset and Countertrade Association; the industry could double in size over the next few years. Yet its very structure serves to mask the build-up of unrecognized financial liabilities of companies… also, critics argue that it fosters corruption, especially in poorer parts of the world…

According to ‘Avascent’, consultants; estimates that defense and aerospace contractors have accrued offsets obligations, i.e., investments they have promised but not yet made– that amount to about $250 billion today, and could increase to almost $450 billion by 2016… However, the industry’s own estimates are lower, but all agree that the trajectory is upward

In a survey of 200 international business leaders; respondents were nearly unanimous on the importance of international business to their organizations, and equally convinced of the value of strong ‘offsets plans’ for the success of their business development efforts… However, the character of offsets– seen as either obligation or opportunity– was more contentious… The pressure to do more and better on offsets is clear…

Meanwhile, many investors that invest in  companies that trade internationally are unaware of the role and risks of offsets— despite the importance of international growth… In addition, many governments using offsets; lack transparency, effective decision-making, little communication… leaving stakeholders to rely on informal networks to navigate the role and risks of offsets in their countries…

Remarkably, offsets are now said to be the main criterion in international trade contract evaluation… offsets may be little-noticed side deals that are negotiated in the shadows, but when it comes to weighing up bids they are at the front of decision-makers’ minds…