CHAPTER 1

An Overview of International Business

Chapter Objectives

After studying this chapter, students should be able to:

1. Discuss the meaning of international business.

2. Explain the importance of understanding international business.
3. Identify and describe the basic forms of international business
activities.
4. Discuss the causes of globalization.
5. Comprehend the growing role of emerging markets in the global
economy.

CHAPTER SUMMARY

Chapter One introduces the topic of international business by initially asking “what is
international business” and then moving on to ask “why is it important to study international
business?” The chapter then provides an introductory definition and explanation of some
of the basic international business terminology, such as importing, exporting, and
multinational corporation.

The chapter moves on to explore the evolution of international business going back to
2000 B.C. examining major developments that have resulted in the growth and maturation
of international business as we know it today. The chapter concludes with an overview of
the text.

WHAT IS INTERNATIONAL BUSINESS?

• International business involves any business transaction between parties from

more than one country. It includes such activities as buying and selling raw
materials, inputs or finished products across borders, operating plants in other
countries to take advantage of local resources, and borrowing money in one country
to finance operations in a second country.
• International business is different from domestic business in that it necessarily
involves transactions that cross national borders while domestic business does not.
Thus, at least one party will have to adjust to a different legal, economic, and cultural
 system; convert its currency into the other party’s currency; and make changes in
how products are produced or the types of products that are produced.

WHY STUDY INTERNATIONAL BUSINESS?

• Students need to study international business for a number of different reasons.

First, students will almost certainly work for a company that is either foreign owned,
domestically owned but has some foreign operations, or domestically owned but is
affected by the global economy. Thus, if students are to be successful and
productive in their careers, it is important that they understand at least the basics of
why companies conduct business across borders. Secondly, since even small
businesses are becoming more active in the international business environment
through activities such as buying and supplying components, students who are
planning to start their own businesses should also be cognizant of international
business.

• Cultural literacy is another reason for studying international business. Because

business today often means international business, it is critical that students develop
the type of cultural literacy that will enable them to be conversant with the global
economy and international marketplaces. Furthermore, students who fail to develop
such skills will find themselves losing ground to their future “competitors” (students,
particularly those from Europe and Japan, who have learned multiple languages,
have had job experiences in other countries and traveled widely).

• Finally, since not all business techniques and tools are developed in the United
States, students need to study international business so that they are aware of
developments taking place in other parts of the globe, such as the use of just-intime
(JIT) systems.

BRINGING THE WORLD INTO FOCUS

This section points out that, despite previous expert predictions of a boundaryless
world, boundaries and borders do matter. That reality impacts all aspects of
international business, including, legal systems, political systems, social
structures, cultural values, taxes, labor, land and other resources. The CAGE
System developed by Pankaj Ghemawat provides a useful framework for
understanding.

INTERNATIONAL BUSINESS ACTIVITIES

• International business can take various forms. Exporting involves selling products
made in one’s own country for use or resale in other countries. Importing involves
buying products made in other countries for use or resale in one’s own country.
Many companies begin their international operations with either importing or
exporting since the risk involved is minimal.

• Merchandise exports and imports refers to trade in goods (also known as visible
trade) while service exports and imports refers to trade in intangible products (also
known as invisible trade).
 • Exporting is important to both large and small firms. For example, the text notes that
54 percent of Boeing Aircraft Company’s sales of $81.7 billion in commercial aircraft
sales were to foreign customers, and that Task Force Tips, a small Indiana
manufacturer of fire hose nozzles, exports one third of its production.

BRINGING THE WORLD INTO FOCUS

The Early Era of International Business
International business has been around for centuries. In fact, its origins can be
traced back as far as 2000 B.C. to the trading that took place between North African
tribes and parts of the Middle East. Greece and the Roman Empire owe part of their
early prosperity to international trade and its associated political and military power.
Some significant trading relationships that endure today were developed during the
Middle Ages.

The colonization of America, brought about in part because important trading routes
to the Middle East were cut off when the Turks conquered Constantinople, brought
new trading avenues, particularly with Europe.

During the colonial period and the subsequent Age of Imperialism, foreign direct
investment and multinational companies grew rapidly as Europeans invested in their
colonial empires in America, Asia, and Africa. The invention of the steam engine,
and its associated low cost transportation, further encouraged foreign investments
in the nineteenth century.

• International investments, in which residents of one country supply capital to those

of a second country, constitute the second major form of international business activity.
Foreign direct investments (FDI) are investments made for the purpose of actively
controlling property, assets, or companies located in foreign host countries. The
country from which the investment flows is referred to as the home country. The
country to which the investment flows is referred to as the host country. Portfolio
investments involve purchases of foreign financial assets (stocks, bonds, certificates
of deposit) for purposes other than control.

• Other forms of international business activity. A licensing agreement allows a firm

in one country to use all or some of the intellectual property of a firm in a second
country in exchange for a royalty payment. A franchising agreement allows a firm in
one country to use the brand names, logos, and operating techniques of a firm in a
second country in exchange for a royalty payment. Management contracts involve
an agreement in which a firm in one country agrees to operate facilities or provide
other management services for an agreed-upon fee.

There are several ways to describe the extent of a firm’s international orientation. At the broadest
level is the international business: an organization that engages in commercial transactions with
individuals, private firms, or public sector organizations that cross borders. The term multinational
corporation (MNC) is used to identify firms with extensive involvement in international business.
More precisely, an MNC is a firm that “engages in foreign direct investment and owns or controls
value-adding activities in more than one country.” MNCs also typically buy resources, create
goods and/or services, and then sell those goods and services in a variety of countries. Control
and coordination usually come from headquarters with subsidiaries making adjustments as
necessary. Non-corporations may sometimes be known as multinational enterprises (MNEs),
while not-for-profits are sometimes known as multinational organizations (MNOs).

THE ERA OF GLOBALIZATION

Globalization can be defined as “the inexorable integration of markets, nation-states, and

technologies…in a way that is enabling individuals, corporations, and nation-states to reach
around the world farther, faster, deeper, and cheaper than ever before.” This is evidenced
by the dramatic growth of international trade over the last several decades. You may also
note the impact of the Global recession. In 2009, trade volumes decreased more than the
world’s GDP did, thus causing the ratio of trade to GDP to fall. The growth in foreign direct
investment (FDI) has also been tremendous (by 2011, the stock of FDI equaled almost 26
percent of that years GDP).

CONTEMPORARY CAUSES OF GLOBALIZATION

Today, firms expand internationally for a variety of reasons. Some of the reasons are
strategic, others are environmental.

Strategic Imperatives

• To leverage core competencies. That is, firms that have skills that help them compete
successfully in one country will often expand in order to further benefit from those skills.
• To acquire resources and supplies. The price and availability of materials, land, labor,
capital, and technology varies across countries. Firms may be able to acquire
resources or produce more efficiently by expanding internationally.
• To seek new markets. Once a company's home market becomes saturated, sales can
be increased by expanding to markets beyond the firm's home country's borders.
• To better compete with rivals. Firms often prefer to not concede markets to a rival.
Therefore, when one firm expands into a new market, other firms in the same industry
may follow.

The Environmental Causes of Globalization

• Changes in the political environment. The collapse of trade barriers (especially since
WWII) and the establishment of new trade agreements (e.g., NAFTA, CAFTA-DR,
GATT/WTO) have promoted greater international trade and investment.

• Technological changes. Phones, faxes, e-mail, air travel, and a host of other
technological changes have made international business easier and more feasible
than ever before.

Globalization and Emerging Markets

• International business activity has expanded geographically with the collapse of
European communism and policy changes in China and India. The markets beyond
North America, Western Europe, and Japan are often referred to as emerging
markets. Some scholars limit emerging markets to Brazil, Russia, India, and China
(BRIC countries). Others use different categorizations.
VENTURING ABROAD
Manchester City in Dubai
It was the beginning of September 2008 and the usual excitement was mounting as
the football transfer window was about to close. Suddenly, out of nowhere it seemed,
came the Abu Dhabi United Group for Development and Investment. Headed by Dr.
Sulaiman Al Fahim, a billionaire in his own right, the group bought the Premier League
team, Manchester City, from the former Thailand Prime Minister, Thaksin Shinawatra.
Negotiations had begun three weeks before and were completed late on Sunday
August 31, at the Emirates Palace Hotel in Dubai. The group is believed to have $221
billion at their disposal. In a stroke, the club’s $147 million plus debt was paid off and
they began to throw their new financial muscle into the transfer market. They snatched
the Real Madrid Brazilian-born striker, Robinho, from the cash-rich Chelsea, which is
backed by Russian billionaire Roman Abramovitch.
Apparently, so cash-rich is the doctor and his group that the money required to
purchase Manchester City (calculated at around $295 million) was wired from reserves
of the brother of the ruler of Abu Dhabi, Sheikh Mansour Bin Zayed Al Nahyan. To put
the purchase of Robinho at $47.8 million into perspective, Abu Dhabi generates that
amount in surplus revenue in five hours by pumping oil. The doctor intends to make
$385 million available to the football club for transfer spending over the next two years.
The key aim of acquiring Manchester City is not only to win football glory in the world,
but also raise the profile of Abu Dhabi itself.
Abu Dhabi has been trying to diversify their economy in recent years, specifically by
making investments abroad in financial services and in tourism. Abu Dhabi’s oil
reserves are estimated to be worth around $1 trillion.
CHAPTER 2
Global Marketplaces and Business
Centers
Chapter Objectives

After studying this chapter, students should be able to:

1. Evaluate the impact of the political and economic characteristics of the

world's various marketplaces on opportunities available to international
businesses.
2. Appreciate the uses of national income data in making business
decisions.
3. Discuss North America as a major marketplace and business center in
the world economy.
4. Describe Western Europe as a major marketplace and business center
in the world economy.
5. Discuss Asia as a major marketplace and business center in the world
economy.
6. Assess the development challenges facing African, Middle Eastern, and
South American countries.

CHAPTER SUMMARY

Chapter Two provides a basic foundation of geographic, economic, and political factors
necessary for understanding international business. The chapter considers the major
centers of international business and analyzes existing patterns of trade. It is designed to
act as a reference chapter for students as they develop their knowledge of the field of
international business.

Most of the world's current economic activity is concentrated in the developed countries of
North America, the European Union and Japan, and the United States) or the Quad (the
Triad plus Canada).

THE MARKETPLACES OF NORTH AMERICA

The United States, Canada, Mexico, Greenland, the nations of Central America, and the
various island nations of the Caribbean make up North America.
 The United States
The United States is the world’s largest economy. It accounts for 21 percent of the
world’s $69.9 trillion GDP (as of 2011). It has the highest per capita income in North
America.

EMERGING OPPORTUNITIES
Classifying Countries by Income Level
This box discusses the importance of knowing income levels when internationalizing.
The box explains the differences among high-income countries (at least $12,476
GDP/capita), middle-income countries (GDP/capita less than $12,476 and $1,025),
and lower-income countries (GDP/capita of $1,025 or less) and their attractiveness to
foreign direct investment.

• The size and political stability of the United States provide the country with a unique
position in the world economy. It accounts for one-eleventh of world trade in goods
and services, and therefore attracts the exports of lower-income nations that are trying
to develop. Also, it is a favorite target for firms from higher-income countries. In
addition, the U.S. dollar serves as the invoicing currency in approximately half of all
international transactions, making it an important component of the foreign currency
reserves owned by governments around the globe. It also attracts money (known as
flight capital) fleeing political turmoil in other countries and longer-term investments.
• International trade, although growing in recent years, is still a relatively small
component of the U.S. economy. This phenomenon is probably due in part to the large
geographic size of the country. Transactions that might constitute international trade
and investment in other parts of the world are just domestic transactions in the United
States.
• Many of the world’s 500 largest industrial companies (as of the year 2010) are
headquartered in the United States.

Canada

• Although the second largest country in the world, Canada has a relatively small
population of 34 million, most of which is concentrated along its southern border with
the United States. The country has close political and economic ties with the United
States, although it has tried to retain a separate cultural identity.
• The United States is a dominant market for Canadian products, receiving more than
three-quarters of Canada’s output in a typical year. The trading relationship between
the United States and Canada is the single largest bilateral trading relationship in the
world.
• Canada’s strong infrastructure and proximity to the U.S. market make it an attractive
location for international businesses.
• Canada’s political stability is currently being threatened by a long-standing conflict
between French-speaking Canada and English-speaking Canada. The conflict is not
only affecting investment in the country, but it is also affecting international business
because firms exporting products to Canada must be aware of the country’s labeling
laws.
 Mexico
• Mexico, the world’s largest Spanish-speaking nation. Mexico follows a federal
system similar to that of the United States under which a new president is elected
every six years.
• In 1994, Canada, Mexico, and the United States initiated the North American Free
Trade Agreement (NAFTA). Mexico signed a similar agreement with the European
Union in 1999. In 2000 it signed free trade pacts with El Salvador, Guatemala, and
Honduras; and in 2004 it signed pacts with Japan and Uruguay. (The role of trade
in
Mexico’s economy is explored in depth in Chapter 10’s opening case, “Trade By
Prosperity: The Case of Mexico.)

Central America and the Caribbean

• The two dozen other nations that make up the North American continent, Central
America, and the island states of the Caribbean have suffered economically as a
result of political instability, a history of U.S. military intervention, inferior
educational systems, a weak middle class, and economic policies that have
created large pockets of poverty. The United States and other developed
countries have contributed to the slow economic development of these countries
by limiting the access of Central American and Caribbean goods into their markets.

Bring the World into Focus

The Canals of Commerce
This box discusses the strategic importance of both the Suez Canal and Panama
Canal, including the impacts upon global trade. This section also highlights the
political and historical significance of the canals.

THE MARKETPLACES OF WESTERN EUROPE

• The countries of Western Europe make up the second component of the Triad,
and are among the most prosperous nations in the world. They can be divided
into (1) the members of the European Union (EU) and (2) the other nations in the
region.
• The members of the European Union have agreed to reduce barriers to trade and
investment among themselves in an effort to achieve greater prosperity. The EU
will be discussed in more detail in Chapter Ten.
• In 2002, twelve of the EU nations eliminated their national currencies, replacing
them with the euro.
• Twenty-eight countries belong to the EU.
• Germany, the third largest economy in the world, is the most economically
powerful nation in the EU. The Bringing the World in Focus section provides an
account of the impact of Mittelstand firms in Germany.
• France is politically strong and is a leading proponent of increased political,
economic, and military union within Europe, and of increasing the powers of the
government of the EU. The United Kingdom has opposed France’s position on
this matter, arguing for freer markets and power at the national, rather than
supranational, level.
• The newest EU members were either part of the Soviet Union (Estonia, Latvia,
and Lithuania) or allied with the Soviet Union politically and economically (Bulgaria,
Czech Republic, Hungary, Poland, Slovakia, and Romania).
 Other countries in Western Europe that are not a part of the EU include Iceland,
Switzerland, Norway, Andorra, Monaco, and Liechtenstein. These countries,
considered rich by the World Bank, follow free market-oriented policies.

Central Europe

• The countries of Central Europe face some common problems as they move
toward capitalism. The Czech Republic, Hungary, and Poland are all now
classified by the World Bank as "high-income" countries and are further along in
their economic development than some of their former peers. They have become
attractive sites to foreign investors.
• Economic development has been slower in Albania, Bulgaria, and Romania
because these countries were slower to develop a consensus as to the direction
they wanted their economies to take.
• The situation is far worse in the former Yugoslavia. Slovenia, Croatia, and
Macedonia have partially avoided the economic ravages of war over control of
Bosnia in the late 1990s. Serbia, Montenegro, and Bosnia are still struggling to
recover. They are not very attractive places for MNCs to invest.

THE MARKETPLACES OF EASTERN EUROPE AND CENTRAL ASIA

The regions of Central (Austria, Albania, the former Soviet satellite states of Bulgaria,
the Czech Republic, Slovakia, Hungary, Poland, Romania, Bosnia-Herzegovina,
Croatia, Macedonia, Montenegro, Serbia, and Slovenia) and Eastern Europe (the
former Soviet Union) continue to undergo the vast economic change that began in
1986 with glasnost (openness) and perestroika (restructuring the economy).

• The Soviet Union collapsed in 1991 as a result of economic and political reforms.
The various countries, of which Russia is the largest, are now part of the Newly
Independent States (NIS).
• The process of transforming their economies from a communist to a capitalist
system was not easy. One of the most important challenges in this process is that
of privatization (selling state-owned property to the public sector). The process
is a painful one that has caused massive unemployment.
• Under the leadership of Boris Yeltsin, Russia's central government staggered from
one financial crisis to another. Vladimir Putin, Yeltsin's successor, overhauled
Russia’s taxation system and has helped somewhat stabilize the economy. The
initiative worked, and government revenues increased.
• The five Central Asian republics of the former Soviet Union (Kazakhstan,
Uzbekistan, Tajikistan, and Kyrgyzstan) declared their independence when the
Soviet Union dissolved in 1991. They are primarily Muslim countries suffering from
scarcity of arable land and from poverty. Per capita incomes range from $934 per
year in Tajikistan to $11,356 in Kazakhstan.
• Afghanistan was invaded by Russia in 1979 (the Russians withdrew ten years
later). After the September 11, 2001, Al Qaeda terrorist attacks, the U.S. military
deposed the Afghan government (the Taliban), which had harbored the terrorist
organization.
• The new Afghan government faces many challenges as it attempts to consolidate
power and promote development.
THE MARKETPLACES OF ASIA

Asia, home to over half the world’s population, produces less than 25 percent of the
world’s GDP. Asia is unique in that it is a source of both high- and low-quality products
and of both expensive and inexpensive labor. Further, the region attracts MNC
investments, and is a major supplier of capital to non-Asian countries. Moreover, its
companies are increasingly pressuring European and North American companies to
improve their operations.

Japan

• Japan, with a population of 128 million, has enjoyed rapid growth over the last 50
years in part because of the close relationship between the Ministry of International
Trade and Investment and the industrial sector.

• Japan, through the use of keiretsus, has also made it difficult for foreign firms to
penetrate its marketplace. A keiretsu is a large family of interrelated firms. Sogo
Soshas (export trading companies that serve as the marketers for the keiretsu in
international markets) facilitate the exports of keiretsu members.
• Although Japan is frequently criticized for its exports, it should be recognized that
its exports are a smaller portion of its GDP than is the case for many nations.
However, the country seemingly restricts importers from competing for its domestic
market.
This topic will be discussed in more depth in Chapter Nine.
• Japan's economy slowed in the 1990s, averaging only .7 percent growth
(compared to 2.7 percent average growth in the world economy).

Australia and New Zealand

• Australia and New Zealand are traditional economic powers in Pacific Asia. Some
40 percent of its population lives in Sydney or Melbourne.
• Australia’s exports capitalize on its natural resources (gold, iron ore, coal, etc.) and
land-intensive agricultural goods (wool, beef, and wheat).
• New Zealand, the other traditional industrial power in Pacific Asia, has
aggressively moved to deregulate and privatize its economy. Australia, Japan,
and the United States account for approximately half of New Zealand's exports
and imports.

The Four Tigers

The Four Tigers – South Korea, Taiwan, Singapore, and Hong Kong – enjoy the
position of being among the fastest industrializing nations in the world. While many
publications still classify the Four Tigers as Emerging Markets, they have in fact
already emerged as indicated by their having achieved high income classification by
the World Bank for more than a decade.

• South Korea has grown rapidly through tight cooperation between the
government and chaebol. Chaebol are large, privately owned conglomerates
such as Samsung, Hyundai, and Daewoo. Today, however, many of the chaebol
are experiencing financial difficulties as a result of the Asian currency crisis. South
Korea has followed a similar recipe for economic growth as Japan, focusing on
 government leadership in the economy, large economic combines for
industrialization, and keeping imports out.
Taiwan, the island off mainland China, has relied on private businesses and export-
oriented trade policies to bring about its phenomenal growth. The country exports
more than 67 percent of its GDP, mainly to the United States, China, and Japan.
Today, Taiwan has outgrown its status as a low-cost manufacturing center, and
instead focuses on high-value-added industries, such as electronics and
automotive parts. In fact, many of Taiwan’s companies are investing in China as
they search for low-cost labor.
• Singapore is another nation that can no longer compete with low-cost labor
countries, and instead has shifted to higher value-added activities, including oil
refining and chemical processing. The country gains much of its economic growth
through the practice of reexporting. So important are exports to Singapore that, in
2011, they made up 171 percent of the GDP. Singapore thrives on reexporting.
The country also is active in sophisticated communications and financial services
for companies in Pacific Asia.
• Hong Kong was ceded back to the PRC in 1997 but will continue to enjoy special
privileges under Chinese rule until 2047. Hong Kong has a highly educated and
productive labor force for industries such as textiles and electronics. The country
is also active in banking and financial services throughout East Asia. In addition,
Hong Kong acts as a middleman for companies that wish to do business with
mainland China. Hong Kong exported 183 percent of its GDP in 2011. Hong Kong
also serves as a bridge between Taiwan and the PRC by converting goods made
in the two enemy nations into Hong Kong goods.

China

• The People’s Republic of China (PRC), the most populous nation in the world, is
also the world’s largest communist country. The PRC’s growth has been governed
by a series of communist policies, the more recent of which have focused on freer
market policies. In fact, it was the freer policies and the hopes for political freedom
that led to the Tiananmen Square massacre in 1989.
• Today, the PRC continues to adopt market-oriented economic policies, but always
under the watchful eye of the Communist Party. The country produces a unique
assortment of goods, the shoddy products of the state enterprises, and the higher
quality products of private firms.
• As the private sector has developed, foreign investment in the country has soared,
particularly by firms located in the Four Tigers that are seeking innovative low-cost
labor.

India

• India, the second most populous country in the world (over one billion persons), is
also one of the world's poorest (with per capita income of $1,488/year). It has relied
on state ownership of key industries as a key to its economic development. India
has also discouraged foreign investment and limited foreign ownership of
companies.
• In the past, India has not seen international trade as being important, and instead
has subsidized globally uncompetitive firms and relied on its large domestic
market. However, in 1991, the Indian government launched a series of economic
reforms that lessened restrictions on foreign investment. The reforms have started
 to pay off, and foreign companies are beginning to consider India for possible
expansion.

Southeast Asian Countries

Other countries in Asia that are affecting international business include Thailand,
Malaysia, and Indonesia. Their GDPs enjoyed annual growth rates averaging over 7
percent from 1980 to 1995. However, the 1997-1998 currency crisis seriously hurt
these countries. Even so, they have continued to be the target of large flows of foreign
investment, particularly by Japanese companies seeking low-cost labor. U.S. and
European MNCs have used these countries as production platforms as well.

THE MARKETPLACES OF AFRICA AND THE MIDDLE EAST

The continent of Africa covers roughly 22 percent of the world's total land area and is
composed of 55 countries. Egypt occupies the northeastern tip of the African continent
and represents the western boundary of what is commonly known as the Middle East.

Africa

• The African continent is home to 1.1 billion people. Though countries on the
African continent are now independent, some vestiges of colonialism remain and
affect international business. The text provides an example of colonial ties,
specifically that Chad, Niger, and the Ivory Coast retain their ties with France and
in doing so, link their currencies with the French franc and follow the legal,
educational, and governmental procedures of France.
• As Africa has shed its colonial rule, the region has undergone political unrest and
civil war; but today, it is turning toward market-oriented policies and multi-party
democracies, and is attracting international businesses.
• Natural resources, particularly oil, and agricultural production are important to the
African economy. Much of the economy still revolves around subsistence farming.
• South Africa is expected to be the dominant power in the continent during the
twenty-first century.

In Practice
Sovereign Wealth Funds
Sovereign wealth funds are a new and controversial source of capital in the world
economy. These are monies derived from a country’s reserves that have been set
aside as an investment benefiting a country’s economy and citizens. These funds
come from a country’s central bank’s reserves that are a result of trade surpluses
and revenues generated by the sale of a country’s natural resources (i.e. oil).

Middle East

• The Middle East (the region located between northwestern Asia and northeastern
Africa) is home to many oil-rich countries. It is also home to political unrest and
 conflict, and the region has been plagued with various wars in the last century,
including the Arab-Israeli wars, the Iran-Iraq war, and the Persian Gulf wars.
In 2011, Saudi Arabia had the largest economy ($577 billion GDP), but Israel had
the highest per capita income ($31,282 per year).
• Countries in the region are trying to plan for a life after oil and are beginning to
diversify their economies. Dubai, for example, is attracting investors by offering
all the benefits of a foreign trade zone.

THE MARKETPLACES OF SOUTH AMERICA

• South America's 13 countries not only share a common political history, but also
share many economic challenges, such as inflation, inefficient producers, and
widespread poverty.
• Until recently, most South American countries have followed an economic policy
of import substitution. Under such a policy, a nation attempts to stimulate the
development of local industry by discouraging imports through high tariff and
nontariff barriers. The trouble with the policy is that in most cases the domestic
market is too small to allow producers to gain the necessary economies of scale
and mass production. Consequently, domestic prices rise above prices in other
markets, putting exporters at a competitive disadvantage. To improve the
competitiveness of the companies and maintain employment levels, governments
usually resort to subsidies and even nationalization. As a result, the government
runs a budget deficit, which leads to inflation and the destruction of middle-class
savings.
• The opposite of import substitution, and the successful policy used by countries
such as Taiwan, Singapore, and Hong Kong, is export promotion, in which a
country grows by expanding its exports.
• Today, the nations of South America are reversing their import substitution policies
in favor of free trade agreements with neighboring countries, and are following a
policy of privatization. As the policies begin to “go into action,” South America’s
role in world trade is expected to increase.