results in stimulating their consumption and demand which cause further specialization which lower the prices of goods and services all over the world. Creation of Industrial Society International trade through specialization of large-scale production, usage of machinery and exploitation of natural resources has resulted in the creation of a new industrial society. Stabilization of Internal Price With the help of international trade the surpluses of the country could be exported to the other country and the deficits of one country may be made up by imports. This will ultimately lead to stabilization of internal price level. Availability of Commoditieswho’sCosts of Production are high With the help of international trade, the countries are able to acquire commodities which they cannot produce locally due to the non-availability of factors of production, insufficient quantity, and due to high costs of production. Europe and Africa could get tea and penicillin, respectively, only because of international trade. Improvement in Transport International trade has resulted in the improvement in the means of transport in all parts of the world. Sovereign Remedy in Times of War andFamine During times of famine, scarcity and war, international trade enables the people of a country to maintain themselves through import of food, cloth and medicine from abroad. Development of Backward Nations With the help of international trade, the economically backward and under-developed countries are able to import machinery and capital goods in exchange for their raw materials, agricultural products and food stuffs. Reduces Monopolistic Exploitation The sense of competition enables the domestic producers keep up the standard in the methods of production. There is no fear of monopoly and competition makes the producers keep the prices at a lower rate. Transfer of Payment Foreign trade makes it possible to effect transfer of payments from debtor country to creditor country. The debtor country exports goods to pay for its debts to the creditor country. National Well-Being For many nations, international trade is literally matter of life and death. For example: for UK and Japan, it is impossible for them to feed, cloth and house their present population, without 51 CU IDOL SELF LEARNING MATERIAL (SLM)
imports from other countries. The survival of these countries depends on the exports of their manufactured goods. Costs of self-sufficiency will be very high when compared to importing. For Americans, the morning cup of coffee would become a luxury without international trade. Changes in the quality of labour and capital International trade brings about fundamental changes in the quality of labour and capital in trading countries. Trade changes the quality of the people teaches them to consume new things also use old things in new ways, change in technical knowledge results in specialization etc. Poor and Backward Nations can become Rich and Forward This is possible only due to international trade. Example: OPEC nations [Organization of the Petroleum Exporting Countries] have developed. The vast petrol reserves would have remained unexploited and Middle East Countries would have remained world’s poorest desert countries. Due to international trade, they have become world’s richest nations. Facilitates Debt Payment International trade depends on the multi-lateral payment system which makes it possible to effect payments from debtor to creditor countries by enabling the former [debtors] to create the necessary amount of export surplus in the Balance of Trade. Thus there are numerous advantages arising from the exchange of goods between individuals living in different countries. Disadvantages of International Trade Exhaustion of Essential Materials International trade may result in the exhaustion of essential materials and minerals of a country. Most of the minerals were exported to other countries. If they had been preserved they would have brought better returns to the country. Affects Domestic Industries International trade may adversely affect the consumption pattern of a country due to the import of cheaply manufactured and at times harmful commodities. Indian handicrafts suffered a severe setback through free trade and unrestricted imports of English textiles. Lopsided Economic Development Due to the operation of comparative costs, international trade leads to specialization and one sided economic development which is not conducive to the prosperity of the country. Evil Effects of Dumping Sometimes, certain countries use international trade to dump their goods on other countries with a view to cheapen the value of the latter goods. 52 CU IDOL SELF LEARNING MATERIAL (SLM)
Dependence on Other Nation Though it ensures higher standard of living for a nation, it makes the countries dependent on foreign markets not for raw materials but also for selling the finished products. This dependence should be reduced or eradicated. Against National Defence It is argued that a nation which depends on foreign sources of supply lacks defence during the war. Eg: England – during the two world war is cited as a proof. England was blocked by German submarines, which completely blocked the imports of goods and essential raw materials. Instability and Economic Planning It is a source of economic instability, and it stands in the way of national economic planning for development and growth. 3.5 PATTERN OF TRADE Over time, the content of a country's imports and exports, as well as the volume of its trade with the rest of the globe, are likely to alter. This is particularly evident in the case of the United Kingdom, where the most significant shifts in trade are as follows: Increase in foreign trade as a percentage of GDP - The United Kingdom has become increasingly reliant on the global economy in recent decades. Exports of products and services accounted for almost a quarter of GDP in the 1950s. This percentage has dropped to roughly a third. The developed world has a larger share of global trade than the developing world. They typically export high-value produced items, while underdeveloped countries export lower- cost raw resources. The developed world has a larger share of global trade than the developing world. Developed countries typically export high-value manufactured items like electronics and automobiles while importing lower-cost primary products like tea and coffee. World exports are dominated by trading blocs such as the European Union. The most trade takes place between established, wealthy countries, particularly between industrial giants like Germany, Japan, the United Kingdom, and the United States. The graph below highlights the continued dominance of developed countries in terms of exports. However, data suggests that the developed world's share is declining. 53 CU IDOL SELF LEARNING MATERIAL (SLM)
Fig 3.1 showing continued dominance of developed countries in terms of exports Relative decline of manufactured goods – Exports of manufactured goods have been continuously declining in comparison to both service exports and imports of manufactured goods. In the 1950s the U.K. exported three times as much manufactured goods as it imported. The United Kingdom is now a net importer of manufactured products (ie imports of goods exceed exports). As a result, the value of services has increased. In the 1950s, goods exports outstripped services by a factor of three. At 3:2, the ratio is now much closer. Changing geographical pattern of trade - For much of the twentieth century, the United Kingdom nevertheless relied heavily on its former empire's countries for trade, importing raw resources and food and exporting finished manufactured goods. Since the 1970s, this pattern has shifted dramatically. Over half of our commerce is now with European Union countries, with a growing share with developing market economies. Shifting patterns of trade Developed countries no longer account for nearly as much of global trade as they previously did. Their share of global merchandise trade fell between 1995 and 2010, while developing countries boosted their contribution. 54 CU IDOL SELF LEARNING MATERIAL (SLM)
China's participation climbed from 2.6 percent to almost 10% throughout this 15-year period. Latin America and the Caribbean raised its market share from 4.5 percent to 5.9 percent within the same time period. Africa's merchandise exports have increased in value from $100 billion in 1995 to $560 billion in 2010. Its share in global trade increased little from 2.0% to 3.20%. Three of the most rapid growing economies are found in East and South Asia: China, India, and the United States and the Republic of Korea. In 2010, they accounted for almost one-third of global exports and two-thirds of exports from developing countries, as seen in the graph below. Fig 3.2 Global Exports of Developing Countries Between 1980 and 2011, developing economies increased their proportion of global exports from 34% to 47% and increased their share of global imports from 29% to 42%. 55 CU IDOL SELF LEARNING MATERIAL (SLM)
World exports Despite the fact that global commerce fell apart during the recent financial crisis, it has now rebounded rapidly, spurred by trade between emerging nations such as Brazil and the Philippines. The graph below depicts the global increase projection. Fig 3.3 showing the Global increase projection The bar chart below clearly demonstrates the industrialized countries' sustained dominance in global commerce. Profits from global commerce amount to millions of billions of dollars for industrialized countries and China. This compares to Brazil's 242 580 USD million, the Philippines' 51 995 USD million, Malawi's 11184 USD million, Uganda's 2357 USD million, and Rwanda's 591 USD million. 56 CU IDOL SELF LEARNING MATERIAL (SLM)
Fig 3.4 showing the industrialized countries' sustained dominance in global commerce Experts anticipate that during the next decade, rapid growth markets will become a more dominant force in global trade, with the Asia-Pacific area expected to have the greatest increase in global commerce through 2020. In addition, trade will become increasingly centered on Asia, the Middle East, and Africa, implying that enterprises' primary geographical location would shift. By 2020, Europe's exports to Africa and the Middle East are expected to be nearly twice as large as those to the United States. Countries like Bangladesh, Vietnam, and parts of Africa will put pressure on China's low-cost manufacturing dominance. 57 CU IDOL SELF LEARNING MATERIAL (SLM)
India and China will be the fastest-growing trading route. According to some estimates, commerce between China and India would account for over a fifth of world trade flows by 2020. There is a tremendous amount of cross-border trading. This, on the other hand, may reflect transactions within and between businesses rather than flows to end users. Within their own organization, many enterprises export finished items across borders. Reasons for Changes in Trading Patterns Changes in comparative advantage - The comparative advantage of a country might fluctuate over time. Most of Europe's and North America's wealthiest countries have seen their comparative advantage migrate away from older industries like textiles, shipbuilding, and steel production and toward services and high-tech \"knowledge industries.\" Impact of emerging economies – The emergence of rising economies such as China, India, and others has had a significant impact on trade patterns. Manufacturing is currently much more prevalent in these countries, while it is far less prevalent in the mature economies of Western Europe, North America, and Japan. Eastern European countries have also seen a rise in manufacturing. Trading blocs and bilateral trading agreements – A trading bloc is a collection of countries that have advantageous commercial agreements with one another, resulting in increased trade among members and some trade diversion from non-member countries (see notes on 4.1.5 for full discussion). The United Kingdom's trading pattern has changed dramatically since joining the European Union. Over half of our goods and services are exported to EU countries, compared to less than 20% to the United States, which has a similar economy to the EU. A bilateral trade agreement is a set of preferential trade agreements between two or more countries. Under the CETA agreement, for example, the EU has specific arrangements with Canada. Changes in relative exchange rates – An appreciation or depreciation of a country's currency rate may occur over time. For example, the United Kingdom began to become a major producer of oil and gas from the North Sea in the 1970s. The oil boom increased the value of the pound against other currencies, making British goods more costly overseas and foreign goods cheaper in the United Kingdom. As a result, much of our manufacturing became uncompetitive, contributing to Britain's long-term de-industrialization. Because price competition became more difficult, the economy had to rely more on high-tech \"knowledge industries\" and services, which are less price sensitive. 3.6 FOREIGN DIRECT INVESTMENT Meaning of Foreign Direct Investment (FDI) 58 CU IDOL SELF LEARNING MATERIAL (SLM)
A foreign direct investment (FDI) is an investment made by a firm or individual in one country into business interests located in another country. Generally, FDI takes place when an investor establishes foreign business operations or acquires foreign business assets in a foreign company. However, FDIs are distinguished from portfolio investments in which an investor merely purchases equities of foreign-based companies. Any investment from an individual or firm that is located in a foreign country into a country is called Foreign Direct Investment. Determinants of FDI The determinants of FDI in host countries are: Policy framework Rules with respect to entry and operations/functioning (mergers/acquisitions and competition) Political, economic and social stability Treatment standards of foreign affiliates International agreements Trade policy (tariff and non-tariff barriers) Privatization policy Foreign Direct Investment (FDI) in India – Latest update 1. A total of USD 35.73 billion in foreign direct investment was received from April to August 2020. It's the highest for the first five months of a fiscal year ever. FDI inflows have surged despite the fact that GDP growth in the first quarter was just 23.9 percent (April-June 2020). 2. Foreign direct investment (FDI) received in the first five months of 2020-21 (USD 35.73 billion) is 13% more than in the first five months of 2019-20. (USD 31.60 billion). Since 1991, when the government opened up the economy and implemented LPG initiatives, the investment climate in India has vastly improved. The loosening of FDI norms is widely credited for the development in this area. Since the country's economic liberalization, many sectors have become partially or entirely accessible to foreign investment. India is now ranked in the top 100 countries in terms of ease of doing business. According to a UN report, India was among the top ten recipients of FDI in 2019, with inflows totaling $49 billion. This represents a 16 percent increase over the previous year. 59 CU IDOL SELF LEARNING MATERIAL (SLM)
In February 2020, the DPIIT announces a policy allowing 100 percent foreign direct investment in insurance intermediaries. In April 2020, the DPIIT issued a new rule stating that any company with a land border with India, or if the beneficial owner of an investment in India is located in or is a citizen of such a nation, can only invest through the Government route. To put it another way, such corporations can only invest with the sanction of the Indian government. In early 2020, the government intended to sell a 100 percent stake in Air India, the country's flag carrier. Benefits of FDI FDI provides the country with numerous benefits. A few of them are discussed farther down. 1. Contributes to economic development by bringing in financial resources. 2. Introduces new technology, skills, knowledge, and so forth. 3. Increases the number of job opportunities for people. 4. Makes the country's business environment more competitive. 5. Enhances the quality of products and services in many industries. Disadvantages of FDI Foreign direct investment, on the other hand, is not without its drawbacks. Here are a few examples: 1. It may have a negative impact on domestic investment and enterprises. 2. Small businesses in a country may not be able to withstand the onslaught of multinational corporations in their industry. As a result of rising FDI, many domestic businesses may close their doors. 3. FDI can have a negative impact on a country's exchange rates. Government Measures to increase FDI in India 1. To entice foreign investment, government initiatives such as the production-linked incentive (PLI) plan for electronics manufacturing in 2020 have been announced. 2. In 2019, the government amended the FDI Policy 2017 to allow 100 percent FDI through the automatic method in coal mining activities, which increased FDI inflow. 3. While FDI in manufacturing was already allowed under the 100 percent automatic route, the government reaffirmed in 2019 that investments in Indian firms involved in contract manufacturing are also allowed under the 100 percent automatic route if done through a legal contract. 60 CU IDOL SELF LEARNING MATERIAL (SLM)
4. The administration also allowed 26 percent FDI in the digital sector. In India, the sector has particularly high return prospects, thanks to favourable demographics, strong mobile and internet penetration, large consumption, and rapid technological adoption, all of which provide a significant market opportunity for a foreign investment. 5. The Foreign Investment Facilitation Portal (FIFP) is the government of India's online single point of contact with investors to facilitate FDI. It is managed by the Ministry of Commerce and Industry's Department for Promotion of Industry and Internal Trade. 6. International direct investment (FDI) is projected to rise further As foreign investors have expressed interest in the government’s plans to allow private train operations and auction off airports. In addition, valuable sectors such as defense manufacturing, which the government increased the automatic route FDI ceiling from 49 percent to 74 percent in May 2020, are expected to draw big investments in the future. 3.7 FOREIGN DIRECT INVESTMENT (FDI) CAPITAL FLOWS: Foreign Direct Investment (FDI) Flows are the total value of cross-border direct investment transactions during a specified time period, usually a quarter or a year. Equity transactions, earnings reinvestment, and intercompany debt transactions are all examples of financial flows. Outward flows are transactions that increase the amount of money invested in a foreign economy by residents in the reporting economy, such as purchases of equity or reinvestment of earnings, minus transactions that decrease the amount of money invested in a foreign economy by residents in the reporting economy, such as sales of equity or borrowing by the resident investor from a foreign economy. India - Net foreign direct investment inflows in % of GDP India's net FDI inflows (as a percentage of GDP) were 1.8 percent in 2019. Though India's net FDI inflows (percentage of GDP) have fluctuated significantly in recent years, they have tended to rise from 1970 to 2019, peaking at 1.8 percent in 2019. What is net FDI inflows (% of GDP)? Foreign direct investment (FDI) refers to net inflows of funds used to acquire a long-term managerial stake (10% or more of voting shares) in a company that operates in a country other than the investors. As represented in the balance of payments, it is the sum of equity capital, earnings reinvestment, other long-term capital, and short-term capital. This series is segmented by GDP and displays net inflows of investment from the reporting economy to the rest of the world. 61 CU IDOL SELF LEARNING MATERIAL (SLM)
Table 3.1 Differences between Foreign Direct Investment (FDI) net inflows and net outflows Date 201 201 201 201 2015 201 201 201 201 201 200 200 9 87 6 4321098 Value 1.8 1.6 1.5 1.9 2.1 1.7 1.5 1.3 2 1.6 2.7 3.6 Chang - - -- e (%) 13.6 23.38 11.8 15.4 22.4 3.04 22.2 -7.4 34.4 38.3 26.7 4% 39 5 4 2 46 The value of inward direct investment made by non-resident investors in the reporting economy is referred to as FDI net inflows. The value of outward direct investment made by residents of the reporting country to external economies is referred to as FDI net outflows. All obligations and assets exchanged between resident direct investment firms and their direct investors are included in inward direct investment, often known as direct investment in the reporting economy. If the ultimate controlling parent is a nonresident, it also covers transfers of assets and liabilities between resident and nonresident fellow firms. Assets and liabilities exchanged between resident direct investors and their direct investment firms are referred to as outward direct investment, or direct investment overseas. If the ultimate controlling parent is a resident, it also covers transfers of assets and liabilities between resident and nonresident fellow firms. Outward direct investment is sometimes known as foreign direct investment. Foreign direct investment is a type of cross-border investment in which a person from one country has control over or a considerable amount of influence over the management of a company in another country. Direct investment also includes investment in indirectly influenced or controlled enterprises, investment in fellow enterprises (enterprises controlled by the same direct investor), debt (except selected debt), and reverse investment, in addition to the equity that gives rise to control or influence. The implementation of the Balance of Payments Manual 6th Edition (BPM6) methodology has resulted in changes to the definition of direct investment, including recasting in terms of control and influence, treatment of chains of investment and fellow enterprises, and presentation on a gross asset and liability basis as a result of the BPM6 methodology. Data on FDI flows is supplied on a net basis (credits from capital transactions minus debits from direct investors and their overseas affiliates). Net asset declines or liabilities rises are recorded as credits, whereas net asset increases, or liabilities decreases are recorded as debits. As a result, FDI flows with a negative sign suggest that at least one of the FDI components is 62 CU IDOL SELF LEARNING MATERIAL (SLM)
negative, and the remaining components are not offset by positive amounts. These are examples of disinvestment or reverse investment. The International Monetary Fund's sixth version of the Balance of Payments Manual (2009) was used to calculate FDI net inflows and outflows (IMF). The World Bank staff estimates foreign direct investment using data from the United Nations Conference on Trade and Development (UNCTAD) and official national sources are augmented by data from the United Nations Conference on Trade and Development (UNCTAD). 3.8 SUMMARY International trade is the exchange of capital, goods, and services across international borders or territories. International trade through specialization of large-scale production, usage of machinery and exploitation of natural resources has resulted in the creation of a new industrial society. Generally, FDI is when a foreign entity acquires ownership or controlling stake in the shares of a company in one country, or establishes businesses there. It is different from foreign portfolio investment where the foreign entity merely buys equity shares of a company. In FDI, the foreign entity has a say in the day-to-day operations of the company. FDI is not just the inflow of money, but also the inflow of technology, knowledge, skills and expertise/know-how. It is a major source of non-debt financial resources for the economic development of a country. FDI generally takes place in an economy which has the prospect of growth and also a skilled workforce. FDI has developed radically as a major form of international capital transfer since the last many years. The advantages of FDI are not evenly distributed. It depends on the host country’s systems and infrastructure. The determinants of FDI in host countries are: Policy framework Rules with respect to entry and operations/functioning (mergers/acquisitions and competition) Political, economic and social stability 63 CU IDOL SELF LEARNING MATERIAL (SLM)
Treatment standards of foreign affiliates International agreements Trade policy (tariff and non-tariff barriers) Privatisation policy Foreign companies invest in India to take advantage of relatively lower wages, special investment privileges like tax exemptions, etc. For a country where foreign investment is being made, it also means achieving technical know-how and generating employment. 3.9 KEYWORDS International trade is referred to as the exchange or trade of goods and services between different nations. Any investment from an individual or firm that is located in a foreign country into a country is called Foreign Direct Investment. Foreign Direct Investment (FDI) flows record the value of cross-border transactions related to direct investment during a given period of time, usually a quarter or a year. 3.10LEARNING ACTIVITY 1. What is meant by Economic Globalization? ___________________________________________________________________________ ___________________________________________________________________________ 2. State the characteristics of Global Economy? ___________________________________________________________________________ ___________________________________________________________________________ 3. List the objectives of Structural Adjustment Program? __________________________________________________________________________ ___________________________________________________________________________ 3.11 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define International Trade? 2. State the features of International Trade? 64 CU IDOL SELF LEARNING MATERIAL (SLM)
3. What is the basis of International Trade? 4. What is the importance of International Trade? 5. State the Patterns of International Trade 6. Give the Meaning of Foreign Direct Investment? 7. What is meant by FDI flows? Long Questions 1. Explain the Advantages and Disadvantages of International Trade? 2. Discuss about the benefits that can be obtained from international trade? 3. Is the emerging global scenario is suitable to international trade? 4. Discuss the reasons for changing in trade patterns? 5. What are the determinants of FDI? 6. Discuss in detail about FDI in India? 7. Discuss the Government measures to increase FDI in India? 8. Bring out the differences between Foreign Direct Investment (FDI) net inflows and net outflows? B. Multiple Choice Questions 1. International trade contributes and increases the world a. Population b. Inflation c. Economy d. Trade Barriers 2. Free international trade maximizes world output through a. Countries reducing various taxes imposed b. Countries specializing in production of goods they are best suited for c. Perfect competition between countries and other special regions d. The diluting the international business laws & conditions between countries. 3. Trade between two or more than two countries is known as 65 a. Internal Business CU IDOL SELF LEARNING MATERIAL (SLM)
b. External Trade c. International Trade d. Unilateral Trade 4. FDI stands for a. Future Direct Investment b. Foreign Direct Investment c. Further Direct Investment d. Fund for Direct Investment 5. FDI is an important source of a. Non-debt finance b. Debt finance c. Equity Finance d. Debt and Equity Finance Answers 1-c, 2-b, 3-c. 4-b, 5-a 3.12 REFERENCES References books Paul Krugman, Obstfeld, Melitz - International Trade: Theory and Policy, Eleventh Edn., Pearson Pawan Kumar Oberoi, International Trade, Global Academic Publishers & Distributors (2nd Edition), 2015 Textbook references Jessie Poon and David L Rigby, International Trade: The Basics, Routledge, 2017 Kevin H. O'Rourke, Power and Plenty: Trade, War, and the World Economy in the Second Millennium: 22 (The Princeton Economic History of the Western World, 30) Website 66 CU IDOL SELF LEARNING MATERIAL (SLM)
https://www.bbc.co.uk/bitesize/guides/zqgggk7/revision/1#:~:text=are%20called%20e xports.,Developed%20countries%20have%20a%20greater%20share%20of%20global %20trade%20than,European%20Union%20%2C%20dominate%20world%20exports https://www.ibef.org/economy/foreign-direct-investment.aspx https://www.investopedia.com/terms/c/capital-flows.asp 67 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 4: TRANSNATIONAL CORPORATIONS AND THE GLOBALIZATION PROCESS STRUCTURE 4.0 Learning Objectives 4.1 Introduction 4.2 Features of Transnational Corporations 4.3 Factors attracting Transnational Corporations 4.4 Reasons for growth of Transnational Corporations 4.5 Definition of Intra-firm Trade 4.6 Differences between inter-industry and intra-industry trade 4.7 International Capital Market 4.8 Structure / Types of International Capital Markets 4.9 Major Components of the International Capital Markets 4.10 Summary 4.11 Keywords 4.12 Learning Activity 4.13 Unit End Questions 4.14 References 4.0 LEARNING OBJECTIVES After studying this unit, you will be able to: State the meaning of Transnational Corporations List the factors affecting Transnational Corporations State the reasons for growth of Transnational Corporations Identify Intra-firm Trade and the benefits of Trade Liberalization Benefits of International Capital Markets 4.1 INTRODUCTION Transnational Corporation (TNCs) known as MNCs (Multinational Corporations) are multinational corporations with operations in several countries. They frequently distribute
their manufacturing across multiple locations or have their various divisions – Head Office and Administration, Research and Development, Production, Assembly, and Sales – dispersed across a continent or the globe. Multinational corporations (MNCs) or transnational corporations are businesses that operate in many countries (TNCs). McDonald's, the American fast-food company, is a large MNC with over 34,000 locations in 119 countries. The bulk of TNCs are from MEDCs (More Economically Developed Countries - MEDCs have a high level of development based on economic indices like GDP) like the United States and the United Kingdom. Several international firms have made investments in other MEDCs. TNCs, on the other hand, invest in LEDCs (Less Economically Developed Countries) - the British DIY shop B&Q, for example, now has stores in China. 4.2 FEATURES OF TRANSNATIONAL CORPORATIONS (TNC) The main features of Transnational Corporations (TNC) are: Giant Size: Transnational corporations have substantial assets and sales. Some TNCs' sales turnover exceeds the gross domestic product of some developing countries. International Business Machines (IBM), for example, has physical assets worth over S billion dollars. Centralized Control: The headquarters of a global corporation are located in the home country. TNC has complete control over all of its branches and subsidiaries, which operate within the parent company's policy framework. International Operations: A global corporation has manufacturing, marketing, and other operations spread across multiple nations. TNCs operate in host nations through a network of subsidiaries, branches, and affiliates. TNC has assets in other nations that it owns and controls. Transnational corporations can easily be recognized as PepsiCo, CNN (the worldwide news network), and Benetton since they have a global presence in practically all of their industries. Oligopolistic Power: The essence of transnational corporations is oligopolistic (few firms in the same field of operation). They have a dominant position in the market due to their enormous size. They also take up other businesses in order to amass enormous economic power. Hindustan Lever Ltd., for example, has increased its market share in personal wash, washing powder, washing bars, shampoos, and skin care creams by acquiring Tata Oil Mills, Ponds India, and other companies. Sophisticated Technology: 69 CU IDOL SELF LEARNING MATERIAL (SLM)
In general, a global firm has advanced technology under its control in order to produce world- class products and services. TNC not only uses capital-intensive technology in manufacturing, but also in marketing. TNCs invest a significant amount of money on research and development (R&D). Professional Management: A transnational firm uses professional skills, specialised knowledge, and training to integrate and manage global operations. To handle complex technologies, large sums of money, and multinational business activities, TNC hires well qualified management. International Markets: A transnational firm has extensive access to foreign markets due to its large resources and better marketing skills. As a result, it can sell any product or service it makes in a variety of countries. Widespread Phenomenon: TNCs may be found in practically every country, with the United States being the largest. TNCs from developing nations operate in other developing countries as well. TNCs in developing countries, on the other hand, pale in comparison to TNCs in industrialized ones. As a result, the TNC phenomenon is largely a phenomenon of industrialized countries. Varied Activities: TNCs have engaged in a wide range of activities. On the one hand, TNCs provide money, technological transfers, research and development of know-how in a variety of disciplines, including product marketing. TNCs, on the other hand, are usually restricted to dynamic goods and product sectors such as minerals, petroleum, pharmaceuticals, chemicals, and heavy engineering goods, among others. Flexibility: TNCs use flexibility and adaptation in their operations to integrate global operations. TNCs must have the ability and flexibility to manufacture and distribute products through constant advancements and innovations in order to suit the ever-changing demands of extremely flexible and dynamic consumers. In today's world, where change is the key to worldwide competitiveness, managers must be able to adapt to the constantly changing demands of the economic, political, and legal environments. Group Performance: TNCs have a number of affiliates spread over the globe. A successful TNC concentrates on collective performance rather than individual affiliate performance. 70 CU IDOL SELF LEARNING MATERIAL (SLM)
4.3 FACTORS ATTRACTING TNCS Factors attracting TNCs to a country may include: Cheap raw materials Cheap labour supply Good transport Access to markets where the goods are sold Friendly government policies Positive impacts of Globalization Globalization is having a dramatic effect - for good or bad - on world economies and on people's lives. Some of the positive impacts are: Inward investment by TNCs helps countries by providing new jobs and skills for local people. TNCs bring wealth and foreign currency to local economies when they buy local resources, products and services. The extra money created by this investment can be spent on education, health and infrastructure. The sharing of ideas, experiences and lifestyles of people and cultures. People can experience foods and other products not previously available in their countries. Globalization increases awareness of events in faraway parts of the world. For example, the UK was quickly made aware of the 2004 tsunami and sent help rapidly in response. Globalization may help to make people more aware of global issues such as deforestation and global warming and alert them to the need for sustainable development. Negative impacts of Globalization Critics of Globalization include groups such as environmentalists, anti-poverty campaigners and trade unionists. Some of the negative impacts include: Globalization operates mostly in the interests of the richest countries, which continue to dominate world trade at the expense of developing countries. The role of LEDCs in the world market is mostly to provide the North and West with cheap labour and raw materials. 71 CU IDOL SELF LEARNING MATERIAL (SLM)
There are no guarantees that the wealth from inward investment will benefit the local community. Often, profits are sent back to the MEDC where the TNC is based. Transnational companies, with their massive economies of scale, may drive local companies out of business. If it becomes cheaper to operate in another country, the TNC might close down the factory and make local people redundant. An absence of strictly enforced international laws means that TNCs may operate in LEDCs in a way that would not be allowed in an MEDC. They may pollute the environment, run risks with safety or impose poor working conditions and low wages on local workers. Globalization is viewed by many as a threat to the world's cultural diversity. It is feared it might drown out local economies, traditions and languages and simply re- cast the whole world in the mould of the capitalist North and West. An example of this is that a Hollywood film is far more likely to be successful worldwide than one made in India or China, which also have thriving film industries. Industry may begin to thrive in LEDCs at the expense of jobs in manufacturing in the UK and other MEDCs, especially in textiles. Anti-Globalization campaigners sometimes try to draw people's attention to these points by demonstrating against the World Trade Organisation. The World Trade Organisation is an inter-government organisation that promotes the free flow of trade around the world. 4.4 REASONS FOR GROWTH OF TNCS 1. Global expansion of a major product with worldwide markets, such as Coca Cola 2. Take-over of foreign competitor firms, such as BMW 3. Merger with foreign firms into one large international company, such as GlaxoSmithKline 4. Vertical integration: acquiring the companies that sell you materials and components, and/or that you sell on to for manufacture, assembly or sales. 5. Horizontal integration: acquiring the companies that make similar components that, along with yours, will go into the final product. 6. Diversification: using the profits from one major company to purchase companies dealing with different products in order to spread risks from loss of sales or financial fluctuations. 7. Risk dispersal: firms may find it advantageous to distribute their plants in a range of countries so that union disputes, government instability, supply disruptions and financial uncertainty in any one country does not disrupt overall production. Production can be switched to alternative plants relatively quickly if need be. 72 CU IDOL SELF LEARNING MATERIAL (SLM)
8. Profit maximisation: firms may set up divisions abroad for a range of reasons: Locate in low business-tax countries and ensure their profits are registered there so they pay minimum tax. Ireland has one of the lowest tax regimes in the EU at 12.5% (20% in UK) and attracts many US firms marketing to Europe. Locate to avoid trade tariffs and tax barriers. Some Japanese car firms set up plants inside the EU to avoid import taxes being imposed on cars from Japan. Locate in low production-cost countries where wages are lower. As these are often the single largest cost for a firm, locating production in low-wage economies can maximise profits at a stroke. Locate in low-regulation countries where there are fewer laws (or less regulation/enforcement) governing employment rights, trade union rights and environmental protection. Over time amalgamations of firms results in a trend towards fewer, larger corporations that operate with an international workforce selling to an international market. As a result of greater economies of scale (the larger the scale, the cheaper it is to do) TNCs are able to make greater profits, enjoy a higher share price and can absorb or take-over smaller, independent national companies or simply put them out of business by capturing the majority of the market and offering a product at a lower price. The divisions of an organization will often be located in countries with different characteristics: The head office registered is usually in the country of origin, or a low business-tax country. Research and Development (R&D) often takes place in countries with highly skilled scientists and engineers and with world-class universities. Branch plants: manufacturing of components takes place where a reliable product can be efficiently produced without threats to long-term continuity. Assembly will often occur close to the major market for the final product. Sales, Marketing and Service: take place close to the main markets for the product. It would be incorrect to imagine all TNCs are involved in manufacturing. Some of the largest are involved in resource extraction and production (oil and gas companies, copper and goldmining), some are financial and insurance companies (major banks), and some are media companies (such as News Corporation – owners of SKY as well as The Times newspaper). 73 CU IDOL SELF LEARNING MATERIAL (SLM)
In terms of their location, TNCs can affect where in the world employment is growing, where it is declining, which national economies are expanding and which are contracting, and the movement and flow of goods, services and employees between various parts of the world. Why are MNCs attracted to developing countries? 1. To extract natural resources like oil, copper and iron from developing countries. MNCs have the skills, physical capital, and technology to extract these natural resources. For instance, Shell Oil extracts oil from Nigeria and Brazil. 2. Lower labour and production costs in developing countries. A MNC can afford to sell its product at a reduced price while still making a solid profit by cutting production costs. In 1995, hourly labour expenses in manufacturing exceeded USD 20 in Germany (USD31.88), Switzerland, Belgium, Austria, Finland, Norway, Denmark, Netherlands, Japan, and Sweden, according to a study, while hourly prices in Indonesia, China, and India were less than USD0.50. Manufacturing labour costs in Sub-Saharan African countries might be considerably lower. 3. To take advantage of a huge and growing markets such as in China, India and Brazil. A multinational corporation may decide to invest in a country not just because of its favorable investment climate (cheap labour, good infrastructure, tax incentives, and so on), but also because of its proximity to another large market. Unilever, for example, produces Dove Brand shampoos in Thailand, which are subsequently exported to neighboring countries such as Malaysia, Singapore, and Hong Kong, as well as sold locally. This lowers transportation expenses, and an MNC will be better able to adapt to changing market demands by being closer to its clients and potential customers. 4. To avoid tariff and other trade barriers. Again, this lowers transportation expenses and, as a result, an MNC's operational costs. According to a study, high-income countries' manufacturing exports to poor countries are subject to an average tariff of 10.9 percent, compared to only 0.8 percent in another high-income country (cited in Stiglitz and Charlton in Fair Trade for all, 255). A MNC could save money and avoid trade obstacles by producing in a developing country rather than exporting to one. 5. To exploit the weak labour, health and environmental regulations in many countries in development in the race to attract more FDI, some emerging governments have granted MNCs increasingly favourable circumstances, including corporation tax breaks. \"Fearing that such suits would discourage investment in the country, Papua New Guinea approved a legislation making it impossible to sue international mining firms outside the country even for the enforcement of health, environmental, or legal rights.\" Why are MNCs good for growth? 1. Multinational corporations (MNCs) can create new jobs in underdeveloped countries. In many cases, large multinational corporations also provide training and education to their 74 CU IDOL SELF LEARNING MATERIAL (SLM)
staff, which not only helps to develop human capital but also facilitates the transfer of technology to developing countries. 2. MNCs have the potential to strengthen a developing country's physical and financial infrastructure. Alternatively, in an effort to entice these MNCs, the government may provide additional infrastructure that not only shifts the PPF outward but also contributes to growth. 3. Productivity increases as a result of MNC competition. “Firms in industries with a substantial multinational presence tend to be more productive, according to studies in Uruguay, Mexico, and Morocco.\" With more competition, prices will fall, and high-cost domestic companies will be outcompeted and forced out of the market. Domestic producers who are cost-effective are the ones who will survive. This boosts the economy's productive and allocative efficiency. Furthermore, according to a research conducted in Taiwan, China, \"the replacement of low-productivity firms with new, higher-productivity entrants accounted for half or more of the technological gain in numerous Taiwan industries during a five-year period.\" 4. The entry of multinational corporations (MNCs) will destabilise local monopolies that abuse market power. MNCs may provide consumers with more options and lower pricing in the country. The latter improves welfare by lowering living costs. 5. Multinational corporations have made it easier for underdeveloped countries to export commodities to high-income ones. As previously stated, intra-firm MNC sales of intermediate products or equipment from one nation's subsidiary to another accounted for about a quarter of foreign exchanges. 6. According to another study, multinational corporations (MNCs) utilise more local inputs over time. This could have a positive impact on the economy by increasing output from domestic enterprises and increasing aggregate demand. 4.5 DEFINITION OF INTRA-FIRM TRADE Intra-firm trade is the trade between two branches of a multi-national corporation. Intra-firm trade consists of trade between parent companies of a compiling country with their affiliates abroad and trade of affiliates under foreign control in this compiling country with their foreign parent group. International trade conducted within a firm, as when a subsidiary of a company exports to or imports from another subsidiary or the parent company in a different country is called as intra-firm trade. The determinants of intra-firm trade 75 CU IDOL SELF LEARNING MATERIAL (SLM)
Intra-firm trade is inextricably linked to the growth of multinational corporations (MNEs) and their growing role in international trade. The expansion of global value chains has been fueled by falling trade and investment costs, as well as the rise of markets (particularly in emerging economies). The number of foreign affiliates per headquarter company is larger in countries with a significant percentage of intra-firm trading. Why a country has a large number of overseas affiliates or parent companies is explained by more fundamental characteristics like capital and skill intensity. However, these trade and investment drivers that help explain MNEs' growing relevance in international trade do not entirely account for observed disparities in intra-firm trade predominance in OECD nations. This is why recent research has focused on additional determinants at the firm level, particularly the role of the so-called \"hold-up problem\" in firms' international sourcing decisions, such as whether to source intermediate inputs intra- firm via a foreign affiliate or at arm's length via an independent supplier. The \"hold-up problem\" occurs when contracting parties underinvest because they are afraid that their counterparty will not follow the contract and instead try to take advantage of them. If two requirements are met, it appears. To begin with, contracts are either not entirely enforceable or incomplete, meaning that it is impossible to include all available facts in a contract. Second, one or both contractual parties' investment is relationship-specific, meaning it has no or little value outside of the relationship. For example, in a relationship between a final products manufacturer and an intermediate input supplier, the final goods producer may demand that the supplier customise the input to his specifications. Because the supplier's investment is relationship-specific and contracts are unfinished, the end goods manufacturer can \"hold up\" the supplier after it has made the investment and then renegotiate the projected surplus. To keep the relationship-specificity of his investment low, the supplier will typically expect such behaviour from the final goods producer and underinvest in the first place. However, if the final products manufacturer makes a relationship-specific investment, not only the supplier but also the final goods producer may experience a bottleneck. There is a two-sided hold-up in this instance, and both the end goods producer and the supplier will underinvest. According to property rights models like Antràs (2003) and Antràs and Helpman (2004), the contracting party that bears the higher burden of the relationship-specific investment should get property rights to the investment, i.e. ownership rights. Because the party holding the investment's property rights will be able to take a larger share of the surplus due to its superior negotiating power, it will have a greater incentive to invest in the first place. When it comes to the relationship between the final goods producer and the supplier, this indicates that if the final goods producer's investment is greater than the supplier's, the final goods producer will pick integration as the organisational form. On the other hand, if the supplier 76 CU IDOL SELF LEARNING MATERIAL (SLM)
makes the bigger relationship-specific investment, the final goods producer will select outsourcing. As a result, inferences can be taken about the product, industry, and country features that cause enterprises to favour intra-firm sourcing over at-arms-length sourcing. The findings suggest that a strong rule of law encourages enterprises to invest and, as a result, intra-firm trade. Furthermore, if the rule of law is poor, corporations will seek to incorporate in those countries. Because these sectors often demand more relationship-specific investment from the parent firm, intra-firm trade is shown to be higher in capital and skill-intensive sectors. Product contractibility is an essential determinant of intra-firm trade. Higher contractibility reduces intra-firm trade: because the hold-up problem is less acute when products are simple to contract, firms rely more on outsourcing than integration. Products that are difficult to contract, on the other hand, are traded more intra-firm. Intra-firm trade and the benefits of trade liberalization Intra-firm trade poses a number of issues for trade policy. When you consider that “local companies” can produce through overseas affiliates or be foreign-owned, trade policymakers can't look at imports and exports in the same way they used to, where exports are positive and imports are a threat to the domestic economy. The increasing importance of FDI and sales of overseas affiliates, as well as intra-firm commerce, have blurred the distinctions between \"Us\" and \"Them.\" Gains from trade in the context of offshoring and heterogeneous firms While trade benefits have been recognized and debated for centuries, some theories have recently highlighted “new” benefits that have grown substantial in light of recent developments in global production and firm organization. In the context of offshoring and heterogeneous enterprises, two sorts of \"new\" profits from trade might be highlighted. First, the benefit from production fragmentation is a direct result of lower trade costs and services trade liberalization (Jones and Kierzkowski, 1990). Because service inputs linking internationally scattered production units can lower the total production cost, international trade incorporating fragmented production blocks delivers additional profits for producers. Each \"block\" is produced in the country with the lowest marginal cost. The production process is more efficient than if executed in a single country as long as this cost advantage can cover the additional fixed costs of fragmentation of production (the service cost to link the blocks). There is also an \"optimal\" number of blocks, because the increased fixed costs of managing a production spread across several countries eventually outweigh the benefits of greater fragmentation. These benefits exist in both foreign outsourcing (each block being an independent firm) and intra-firm commerce in a vertically integrated structure (a single firm). Communication, 77 CU IDOL SELF LEARNING MATERIAL (SLM)
transportation, and logistics services, as well as financial and corporate services, are examples of \"services inputs\" that connect the blocks. Without these services, there is no \"global value chain,\" and the benefit of offshore is directly proportional to their efficiency. According to a case study conducted by the Swedish National Board of Trade, a Swedish business need around 40 distinct services in order to establish itself overseas and maintain the supply chain. The second source of gains is intra-industry reallocation of market shares among heterogeneous businesses, i.e. enterprises with varying levels of productivity, as a result of trade liberalization. Trade liberalization, according to Melitz (2003), forces the least productive enterprises out of the market while the most productive firms gain market share. The end consequence is an increase in overall industry productivity. Firms are now more heterogeneous than ever before as a result of changes in firm and international production borders. They have varied levels of productivity depending on their organisation and size. Because of the variety of cost-effective strategies focusing on competitive advantages in terms of location, size, and organisational options, firms that are comparatively less productive and not participating in outsourcing can survive with MNEs in the same industry. As shown in the following section, trade liberalization does not result in a single type of firm and has a mixed impact on the decision to outsource or vertically integrate. Other additional sources of profit can be noted as well, such as an increase in product diversity or technical spillovers related to FDI and trade interactions. It's not easy to quantify these new trade benefits, and classic CGE models for measuring welfare gains aren't yet capable of doing so. When Corcos et al. (2009) examine the European Union, they show that profits from trade are substantially bigger when selection effects are taken into account (i.e., the reallocation of market shares towards the most productive firms). Blonigen and Soderbery (2009) show that when product variety is taken into consideration, the welfare gains from trade are significantly bigger. Because certain kinds are generated by foreign-owned affiliates, they are linked to FDI. A major task for trade modellers will be to develop new techniques to capture these benefits so that policymakers are properly informed about the benefits of trade liberalization. Trade liberalization and intra-firm trade Another key result of the intra-firm trade study is that trade liberalization affects company boundaries. Lower trade costs are a result of trade liberalization, which reduces the costs that businesses encounter while trading goods or services (including tariffs and various non-tariff barriers, as well as transport and communication costs). Reduced trade barriers result in decreased variable costs for companies that import intermediate goods from other countries. As a result, some enterprises that previously sourced inputs domestically will now find it more profitable to get inputs from other countries, resulting in increased trade. 78 CU IDOL SELF LEARNING MATERIAL (SLM)
Tariffs have an unequal influence on intra-firm trade and sourcing methods, according to Diez (2010). Trade liberalization in the North improves the incentives for offshoring in a North-South theoretical paradigm where enterprises from the North offshore some of their production to the South (because the firms that produce abroad face a lower tariff on their intra-firm imports). Lower tariffs in the North boost intra-firm trading as a result of this. When tariffs in the South are reduced, the opposite occurs. Firms exporting to the South now benefit from lower costs (lower tariffs). For companies who are already producing in the South, there is no unique benefit.(the firms that have offshored their production). Because domestic firms that do not engage in intra-firm trade have a higher market share, trade liberalization in the South is projected to lower intra-firm trade. When looking at data from the United States, this simple model has empirical support. Diez (2010) discovers a positive correlation between US tariffs and the share of US intra-firm imports, as well as a negative correlation between tariffs abroad and US intra-firm imports. Is trade liberalization, on the other hand, equally beneficial to vertical FDI and foreign outsourcing, with the ratio of intra-firm to arm's length trade remaining unchanged? Trade liberalization, according to Antràs and Helpman (2004), will increase international outsourcing more than vertical FDI. All enterprises that acquire inputs from outside the country will choose international outsourcing to vertical FDI in component-intensive industries. As a result of trade liberalization, international outsourcing and arm's length trade will rise, but intra-firm trade will not. Firms engage in both international outsourcing and vertical FDI in headquarter-intensive industries. Following trade liberalization, some enterprises that previously sourced the input locally will now do so through international outsourcing, while others that have already done so will find it more profitable to source the input through a foreign affiliate. The first effect is larger, according to Antràs and Helpman (2004), with more enterprises switching from domestic manufacturing to international outsourcing than from international outsourcing to vertical FDI. As a result, in both component- and headquarter-intensive industries, trade liberalization will reduce the share of intra-firm trade relative to arm's length trade. Despite the complexity of the relationships depicted, this simple theoretical framework falls short of replicating all of the complexities of enterprises' sourcing strategy and the various sorts of interactions between domestic and foreign markets for final goods and intermediate inputs. This approach, on the other hand, is valuable for illustrating the trade-offs and understanding the consequences of trade liberalization. Trade liberalization entails the withdrawal of enterprises that are not productive enough in the domestic market in all industries. This intra-industry reallocation, as previously stated, is a significant source of productivity improvements associated with trade liberalization (Melitz, 2003). Trade liberalization supports offshore in general and overseas outsourcing in particular for the provision of inputs. Vertical integration abroad may be the chosen strategy of the most productive enterprises, depending on sector-specific factors. However, trade liberalization is 79 CU IDOL SELF LEARNING MATERIAL (SLM)
unlikely to boost vertical integration and, as a result, intra-firm trade in the absence of FDI liberalization or other measures that can change the fixed costs of overseas investment. In their econometric research of the determinants of intra-firm trade, Bernard et al. (2010) found no clear association between the percentage of intra-firm trade and trade liberalization. While policymakers should be aware of the impact of high trade costs on efficiency and welfare, there is no reason to believe that a reduced percentage of intra-firm trade is an indication of policy failure. According to the hypothesis, with trade liberalization, this proportion should decrease, and the ratio of intra-firm trade to arm's length trade shows sector-specific strategic alternatives for corporations that can lead to improved productivity through vertical integration and outsourcing. Intra-firm trade advantages are part of a larger set of gains connected to a more efficient organisation of world production in global value chains, rather than being a direct result of trade flows within enterprises. Outsourcing can help you attain similar results. The analysis' first policy implication is that trade policy should encourage efficient business rearrangement. This can be accomplished by giving independent overseas suppliers and linked enterprises equal access and allowing economic drivers (rather than policy determinants) to determine a firm's ideal sourcing strategy. This indicates that liberalization of trade and investment should be part of market access. (And in the case of services trade, both cross-border and commercial presence commitments). Intra-firm trade and trade agreements In contrast to the usual portrayal of trade flows in terms of final goods, the literature on outsourcing has underlined that trade in intermediate inputs brings significant issues in trade policy. The “hold-up problem” in international trade has already been identified as a result of specialised inputs and difficult-to-enforce contracts with foreign suppliers. With a low volume of inputs trade, the international hold-up issue might cause distortions and result in an inefficient consequence. Some authors have proposed that new sorts of active trade policies, such as subsidies for intermediate inputs paired with free trade in final commodities, could stimulate a return to an efficient level of intermediate trade. Such policy choices, on the other hand, are not very realistic, as they would produce distortions between inputs and final products, resulting in changes in the effective rate of protection. Vertical integration and intra-firm trading can help firms handle the hold-up problem to some extent. When the buyer owns the supply (or vice versa), the nature of the contract changes, and neither party can truly \"threaten\" the other because they are both controlled by the same entity. Vertical integration, it could be argued, mitigates the consequences of the international hold-up problem and returns trade policy to normal models. Nonetheless, makers of finished goods and their suppliers must make relationship-specific investments. Both the integrated firm and the arm's length relationship are examples of this. In integrated firms, bargaining concerns are of a different character, yet they nevertheless exist. 80 CU IDOL SELF LEARNING MATERIAL (SLM)
Furthermore, trade agreements are influenced by the presence of foreign-owned enterprises in the home economy as well as domestic investors overseas. Cross-border ownership, according to Blanchard (2006), affects the role of trade agreements and the way governments negotiate. First, in the context of international investment, the traditional terms of trade externality through which large countries can extract rents from their trading partners should be re-examined, given that \"domestic welfare\" includes revenue from foreign-owned affiliates, and some of the \"rents\" are extracted from domestic producers who produce abroad. (Through custom duties on intra-firm trade). As a result, in the existence of international vertical integration, the \"ideal tariff\" should be lower. This \"FDI-terms of trade effect\" has a number of ramifications. First, allowing foreign investors access to the market can help the investment-host country's export sector overcome tariff hurdles in other countries.Country A, for example, allows investors from country B to set up shop. Once nation B is aware that country A has foreign affiliates, it should reduce tariffs for country A. (as its optimal tariff is now lower because of the revenues of foreign affiliates). This is a lesser-known benefit of FDI, and it may explain why FDI is more frequently permitted in export sectors than in import-competing businesses. A conclusion is that FDI liberalization can lead to unilateral liberalization due to its terms of trade effect, not simply as a substitute for tariff liberalization (tariff-jumping FDI). The ideal tariff for a country is lower the larger the stock of (vertical) FDI. As a result, trade liberalization can be aided by investment liberalization. However, this inference should be seen with caution, as it could have the opposite effect in import-competing industries, where investment should support higher tariffs, which in turn boost incentives for tariff-jumping FDI, creating a vicious cycle. Furthermore, the link between increasing FDI at home and lower tariffs encountered by domestic exporters abroad might be used as a justification for discriminating preferential trade agreements, as opposed to the first-best alternative of non-discrimination multilateral trade liberalisation. Furthermore, international ownership has two additional cost-shifting impacts. Trade policy can shift rents from local producers (who are partially foreign-owned) to domestic consumers by altering the local price compared to the world price. The local relative pricing can then be modified to shift rents between sectors with a high percentage of foreign ownership and those with a majority of domestic ownership. There is no evidence that governments have been motivated to utilise trade agreements to implement such price manipulations in the real world (or have been successful in doing so). But the point is that international investment may be used to evaluate the entire political economics of trade talks. One area of concern for trade policymakers should be the influence of trade agreements not just on “country” welfare but also on affiliate income and revenues of local foreign-owned enterprises (who also contribute to “domestic” wellbeing). This tends to make trade agreements and governments' jobs more difficult. 81 CU IDOL SELF LEARNING MATERIAL (SLM)
Another aspect of the rise of offshoring (whether through outsourcing or vertical integration) is that the interaction between suppliers and customers should be given more attention. The hold-up problem and the bargaining challenges raised in the new trade literature suggest that trade agreements should focus on domestic measures that can impact negotiating between suppliers and purchasers in addition to traditional market access concerns. The rule of law has long been recognised as a crucial predictor of intra-firm commerce. In particular, the legal protection offered to businesses, contract law, and various aspects of competition policy may be relevant. This is a new point of convergence between trade and competition policy. In the future, trade agreements may need to take into account the bargaining conditions between suppliers of specialised inputs and purchasers, in addition to maintaining fair competition between domestic and foreign suppliers. The impact of trade liberalisation on these negotiating conditions may explain a new form of benefit from free trade, which is an intriguing suggestion. Ornelas and Turner show that when trade is subjected to tariffs, the typical hold-up problem is exacerbated. Lower rates assist to alleviate the backlog in two ways. First, they boost international suppliers' incentives to make cost-cutting investments. Higher input trade flows result from cheaper costs (closer to the efficient level). Second, trade liberalisation has an impact on organisational structure and supports vertical integration, which alleviates the bottleneck problem. More vertical integration will occur as a result of the firm's decision to incur the fixed cost of investment in the setting of decreasing trade costs. As a result, trade liberalisation can be considered as a solution to the bottleneck problem, which is an added benefit of free trade. Finally, standards are a type of trade barrier that has an impact on business decisions in global value chains. Standards can be considered as part of the lock-in costs supported by suppliers when they invest to meet the needs of customers, whether established by governments or the private sector. On the one hand, standards can stifle competition (by excluding local providers), but they should not be used as new trade barriers or a source of underinvestment. Standards, on the other hand, can be supported by leading companies (global purchasers) and benefit suppliers by assisting them in upgrading and developing their capabilities. In the context of global value chains and intra-firm trade, this is another area where policymakers should concentrate their efforts. Definition of inter-firm trade: Inter-firm trade is the exchange between nations of product of different industries; examples include computers and aircraft for textiles and shoed, or finished manufactured items traded for primary materials. Inter-industry trade involves the exchange of goods with different factor requirements. Nations having large supplies of skilled labour tend to export sophisticated manufactured products while nations with large supplies of natural resources export resource-intensive goods. Much of inter-industry trade is between nations having 82 CU IDOL SELF LEARNING MATERIAL (SLM)
vastly different resource endowments (such as developing countries and industrial countries) and can be explained by the principle of comparative advantage. Example: Supplier of raw materials and a company that is importing the raw materials, which is based in another country. Inter-industry trade is based on inter-industry specialization. Each nation specializes in a particular industry in which it enjoys a comparative advantage. As resources shift to the industry with a comparative advantage, certain other industries having comparative disadvantages contract. Resources thus move geographically to the industry where comparative costs are lowest. As a result of specialization, nation experiences a growing dissimilarity between the products that it exports and the products that it imports. Although some inter-industry specialization occurs, this generally has not been the type of specialization that industrialized nations have undertaken in thepost World War II era. Rather than emphasizing entire industries, industrial countries have adopted a narrower form of specialization. They have practiced intra-industry specialization, focusing on the production of particular products or groups of products within a given industry. With intra-industry specialization, the opening up of trade does not generally result in the elimination or wholesale contraction of entire industries, within a nation; however, the range of products produced and sold by each nation changes. The existence of intra-industry trade appears to be incompatible with the models of comparative advantage. Intra-industry trade involves flows of goods with similar factor requirements. Nations that are net exporters of manufactures goods embodying sophisticated technology also purchase such goods from other nations. Much of intra-industry trade is conducted among industrial countries, especially those in Western Europe, whose resource endowments ae similar. The firms that produce these goods tend to be oligopolies, with a few large firms constituting each industry. 4.6 DIFFERENCES BETWEEN INTER-INDUSTRY AND INTRA- INDUSTRY TRADE Inter-industry trade is a trade of products that belong to different industries. For instance, the trade of agricultural products produced in one country with technological equipment produced in another country can be classified to be an inter-industry trade. Countries usually engage in inter-industry trade according to their competitive advantages. Intra-industry trade, on the other hand, is a trade of products that belong to the same industry. As it has been noted, “intra-industry trade (IIT), that is trade of similar products, has been a key factor in trade growth in recent decades. These trends have mostly been attributed to the fragmentation of production (outsourcing and offshoring) as a result of Globalization and new technologies”. 83 CU IDOL SELF LEARNING MATERIAL (SLM)
Explanation of Intra-Industry Trade by Economic Theory It first sight it may seem strange that countries do engage in importing and exporting same type of products with their international partners. However, there are a range of benefits intra- industry trade offers businesses and countries engaging in it in general. The benefits of intra-industry trade have been explained by various business researchers, and all of these benefits can be summarized into three points that which is illustrated by Johnson and Taylor (2009) in the following way: Firstly, intra-industry trade increases the variety of products the same industry, which is beneficial to both, businesses, as well as consumers. This benefit of intra-industry trade is possible because today product range from the same industry can be highly differentiated, and intra-industry trade will provide the opportunity of having a vast range of differentiated products within the markets of trading partners. Secondly, intra-industry trade gives opportunity for businesses to benefit from the economies of scale, as well as use their comparative advantages. In other words, countries will get more economic benefits if they concentrate on producing specific types of products within specific range, according to their comparative advantages rather than producing all ranges of specific products. Thirdly, inter-industry trade stimulates innovation in industry, and can assist the economy in cases of short-term economic fluctuations. The main benefit of intra-industry trade can be explained in simple terms by using an example of car trade between Japan and Germany. Let’s suppose Toyota, a Japanese car company mainly produces family cars, and German car manufacturer Audi concentrates on producing sport cars. Accordingly, when Toyota produces more family cars, the lower will be the unit cost, and similarly, more sports cars are produced by Audi, the lower unit price of the car will be. 4.7 INTERNATIONAL CAPITAL MARKET: Meaning of International Capital Market International capital market is that financial market or world financial center where shares, bonds, debentures, currencies, hedge funds, mutual funds and other long term securities are purchased and sold. International capital market is the group of different country's capital market. They associate with each other with Internet. They provide the place to international companies and investors to deal in shares and bonds of different countries. Benefits of International Capital Market International capital markets are the same mechanism as domestic capital markets, but they operate on a worldwide scale, allowing governments, businesses, and individuals to borrow 84 CU IDOL SELF LEARNING MATERIAL (SLM)
and invest beyond national borders. International capital markets give the following benefits in addition to the benefits and purposes of a domestic capital market: 1. Higher returns and cheaper borrowing costs. These enable businesses and governments to access overseas markets and new sources of funding. Companies cannot borrow in many domestic markets because they are either tiny or too expensive. Companies, governments, and even individuals can borrow or invest in other nations for higher rates of return or lower borrowing costs by leveraging international capital markets. 2. Diversifying risk. Individuals, businesses, and governments can access additional borrowing and investment options in multiple nations thanks to international financial markets, which decreases risk. According to the notion, not all markets will contract at the same time. The capital markets are divided into two categories: primary and secondary. The primary market is where new securities (most commonly stocks and bonds) are launched. When a company or government entity needs money, it issues (sells) securities to primary market investors. As intermediaries, large investment banks aid in the issuance process. The primary market is useful but less essential than the secondary market because it is confined to issuing only new securities. The secondary market is where the great bulk of capital transactions take place. Stock exchanges (the New York Stock Exchange, the London Stock Exchange, and the Tokyo Nikkei), bond markets, and futures and options markets are all part of the secondary market. All of these secondary markets deal with securities trading. Securities is a broad phrase that refers to a variety of financial instruments. Stocks and bonds are perhaps the most familiar to you. Equity securities, which represent ownership of a portion of a corporation, and debt securities, which represent a loan from the investor to a company or government agency, are the two main types of securities available to investors. Creditors, often known as debt holders, purchase debt securities in exchange for future income or assets. The bond is the most frequent type of debt instrument. When investors purchase bonds, they are lending money to the bond issuers. In exchange, they will get interest payments for the life of the bond at a predetermined rate, as well as the principal when the bond matures. Bonds can be issued by a variety of organisations. Most people are familiar with stocks, which are a sort of equity security. When investors purchase stock, they are purchasing a portion of a company's assets and earnings. If a company is successful, the price that investors are prepared to pay for its shares will often climb, resulting in a profit for shareholders who purchased stock at a lower price. However, if a firm does not perform successfully, its stock may lose value, and shareholders may lose money. Both general economic and industry-specific market factors influence stock prices. 85 CU IDOL SELF LEARNING MATERIAL (SLM)
The essential to remember with either debt or equity securities is that in primary market issuances, the issuing body, be it a firm or the government, only receives cash. The security is traded once it is issued, but the corporation receives no further financial advantage from it. Companies are motivated to keep the value of their equity securities or to repay their bonds on time so that when they need to borrow money or sell additional shares in the market, they may do so with confidence. For companies, the global financial, including the currency, markets (1) provide stability and predictability, (2) help reduce risk, and (3) provide access to more resources. Importance of International Capital Market One of the main purposes of capital markets is to create economies of scale and promote economic efficiency. On a global scale, it refers to the simplicity with which one can acquire and sell securities, as well as convert them into cash when necessary. It assists in the immobilization of idle savings and the channeling of those funds into more productive investment. They balance the supply and demand of funds, maintaining financial security and assuring the most efficient use of resources, which aids capital formation and economic progress. International capital markets operate on a global scale, transcending national borders. When compared to a domestic capital market, they offer enterprises to access foreign markets at a lower borrowing cost and higher returns. This also assists in risk diversification. Due to its liquid market, it provides an avenue for long-term investment and continuing availability of such funds, allowing the possibility of turning an asset into cash while keeping the principal value intact. Functions of international capital market International capital markets provide forums and mechanisms for governments, companies, and people to borrow or invest (or both) across national boundaries. Where new securities (stocks and bonds are the most common) are issued. The company receives the funds from this issuance or sale. Purposes of the International Capital Market 1. Expands the Money Supply for Borrowers The international capital market connects borrowers and lenders from several national capital markets. A corporation that is unable to raise capital from investors in its home country can look for funding elsewhere, allowing it to pursue a project that would otherwise be impossible. Firms in nations with tiny or growing capital markets value the ability to expand beyond their own country. An increased money supply also assists tiny but potential businesses that might not otherwise be able to obtain funding due to fierce competition for capital. 2. Reduces the Cost of Money for Borrowers 86 CU IDOL SELF LEARNING MATERIAL (SLM)
Borrowing costs are reduced when the money supply is increased. Money's \"price\" is determined by supply and demand, just like the prices of potatoes, wheat, and other commodities. When the supply of anything grows, the price—in the form of interest rates— decreases. As a result of the surplus supply, a borrower's market emerges, driving interest rates and borrowing costs lower. Projects that were once thought to be unfeasible due to low predicted returns may now be viable with a decreased cost of capital. 3. Reduces Risk for Lenders The international capital market increases the number of credit options available. As a result, a wider set of options helps lenders (investors) minimise risk in two ways: 1. Investors have a wider range of options from which to pick. If one investment loses money, it might be countered by profits in other investments. 2. Investors profit from investing in international assets since certain economies are rising while others are declining. Holding international securities with independent price movements reduces risk for investors. Small, would-be borrowers still face significant challenges in obtaining loans. Interest rates are frequently expensive, and many entrepreneurs have no collateral to put up. See the Entrepreneur's Toolkit chapter titled \"Microfinance Makes a Big Impression\" for several unusual techniques of putting funds into the hands of tiny businessmen (especially in developing countries). 4.8 STRUCTURE / TYPES OF INTERNATIONAL CAPITAL MARKETS There are primarily two types of International Capital Markets, i.e. 1. Primary Market (organisations raising funds by issuing securities) and 2. Secondary Market (facilitating the buying and selling of such securities). Governments and organizations strive to raise funds by issuing new securities through underwriting in a Primary Market, also known as a New Issue Market (NIM). It is advantageous to long-term capital. When a corporation issues securities directly to investors, the company receives the money and issues security certificates to the investors. Initial Public Offerings, Rights Issues, and Preferential Issues are all options for issuing securities in this market. Merchant Bankers, Underwriters, Bankers to Issue, Portfolio Managers, Debenture Trustees, Registrars to an Issue, and Share Transfer Agents are all examples of primary market intermediaries. The purchasing and selling of previously issued securities is referred to as Secondary Markets, also known as aftermarket, share market, or stock market. Stockbrokers and sub brokers are the key intermediates, and their job is to create liquidity in securities. Some of the 87 CU IDOL SELF LEARNING MATERIAL (SLM)
goods traded are equity shares, debentures, government securities, the SEBI risk management system, commercial papers, and bonds. 4.9 MAJOR COMPONENTS OF THE INTERNATIONAL CAPITAL MARKETS International Equity Markets The equity markets are where companies sell their stock. All stock traded outside of the issuing company's home country is included in the international equity markets. To support local and regional operations, many significant global corporations aim to take advantage of global financial hubs and issue shares in important markets. Arcelor Mittal, for example, is a Luxembourg-based worldwide steel business that is traded on the stock markets of New York, Amsterdam, Paris, Brussels, Luxembourg, Madrid, Barcelona, Bilbao, and Valencia. While the daily value of global markets fluctuates, worldwide equity markets have grown significantly in the last decade, providing global enterprises with more choices for funding their global operations. The following are the main drivers of increased growth in international equity markets: Growth of developing markets. Domestic enterprises in emerging countries aspire to expand into global markets and take advantage of cheaper and more flexible financial markets as their economies grow. Drive to privatize. The general trend in developing and emerging markets over the last two decades has been to privatise formerly state-owned firms. These companies are typically enormous, and when they sell some or all of their stock, it injects billions of dollars into local and global markets. These shares are purchased by domestic and international investors who want to participate in the local economy's growth. Investment banks. Investment banks frequently lead the way in the expansion of global equities markets, owing to growing prospects in new emerging economies and the necessity to simply expand their own companies. These specialised banks want to be retained by significant corporations in emerging nations or governments pursuing privatisation to issue and sell equities to international investors with deep wallets. Technology advancements. Technology's development into global finance has provided new opportunities for investors and businesses all around the world. Technology and the Internet have made trading stocks and, in some situations, issuing shares by smaller companies more efficient and less expensive. International Bond Markets Bonds are the most prevalent type of financial instrument, and they are essentially a loan from the bondholder to the bond issuer. All bonds sold by an issuing corporation, 88 CU IDOL SELF LEARNING MATERIAL (SLM)
government, or organization outside of their native country are included in the international bond market. Companies that do not wish to issue more equity shares and dilute existing shareholders' ownership rights seek to obtain capital using bonds or debt (i.e., money). Companies may use the foreign bond markets for a variety of reasons, such as to construct a new manufacturing facility or to expand operations in one or more countries. International bonds come in a variety of shapes and sizes. Foreign Bond A foreign bond is a bond issued in the currency of the country in which it is sold by a firm, government, or other organization in another country. Foreign bonds are subject to foreign exchange, economic, and political risks, and many knowledgeable purchasers and issuers employ elaborate hedging tactics to mitigate these risks. Samurai bonds, for example, are yen-denominated bonds issued by multinational corporations in Japan. Other names for similar binding configurations exist, as one might imagine. Yankee bonds are foreign bonds that are sold in the United States and are denominated in US dollars. Bulldog bonds are the name given to these foreign bonds in the United Kingdom. Dragon bonds are foreign bonds issued and traded throughout Asia, with the exception of Japan, and are often denominated in US dollars. Foreign bonds are usually governed by the same rules and regulations as apply to domestic bonds in the nation where they are issued. They are slightly more expensive than Eurobonds due to regulatory and reporting requirements. The rules add tiny fees that can build up over time, considering the scale of many corporations' bond issuance. Eurobond A Eurobond is a bond that is issued outside of the country that it is denominated in. Eurobonds are the most popular type of foreign bond since they are not controlled by the governments of the countries where they are sold. A Eurobond is a bond issued by a Japanese firm that is denominated in US dollars and sold only in the United Kingdom and France. Global Bond A global bond is one that is sold in multiple global financial hubs at the same time. It has a single currency, which is commonly US dollars or Euros. The corporation can lower its issuance expenses by offering the bond in multiple markets at the same time. This option is normally only available to higher-rated, creditworthy, and frequently extremely large businesses. Turnover of International Capital Market Almost all financial markets have been converted into international capital markets since the introduction of the computer and the Internet, as well as the financial market revolution in 2010. Hong Kong, Singapore, and the World Trade Center in New York are three examples. Foreign currency trading was the first activity on the international capital market. Companies must obtain a certificate in order to trade on the worldwide market following the globalisation 89 CU IDOL SELF LEARNING MATERIAL (SLM)
of the financial sector. If an Indian business wishes to sell shares in France, it should get a document known as a Global Depository Receipt (GDR). International capital market's daily turnover has crossed $ 5 trillion. Because you may buy foreign countries' shares, debentures, and mutual funds on the international capital market, it is highly helpful for lowering the risk of a small business. Distinct countries have different economic environments, so if one country has a loss as a result of a financial crisis, your investment in that country may suffer losses, but you can compensate for this loss by investing in another country. As a result, this strategy will lower overall risk. 4.10 SUMMARY Companies that operate in several countries are called Multinational Corporations (MNCs) or transnational corporations (TNCs). Transnational companies, with their massive economies of scale, may drive local companies out of business. MNCs can provide new employment to the developing countries. MNCs are more likely to crowd out local firms in developing countries, leading to higher concentration ratios on the production side. Inter-firm trade occurs between different types of companies located in different countries. Intra-firm trade is the trade between two branches of a multi-national corporation International capital market is that financial market or world financial centre where shares, bonds, debentures, currencies, hedge funds, mutual funds and other long term securities are purchased and sold. 4.11 KEYWORDS MNCs (Multinational Companies) these are large businesses that operate in a number of countries. Intra-firm trade is the trade between two branches of a multi-national corporation. Inter-firm trade occurs between different types of companies located in different countries. International capital market is the group of different country's capital market. 4.12 LEARNING ACTIVITY 1. What do you mean by Transnational Corporations? 90 CU IDOL SELF LEARNING MATERIAL (SLM)
___________________________________________________________________________ ___________________________________________________________________________ 2. State the factors attracting Transnational Corporations? ___________________________________________________________________________ ___________________________________________________________________________ 3. List the features of Transnational Corporations? __________________________________________________________________________ ___________________________________________________________________________ 4. List the determinants of intra-firm Trade? ___________________________________________________________________________ ___________________________________________________________________________ 5. What is meant by inter-firm trade? ___________________________________________________________________________ ___________________________________________________________________________ 6. What are International Capital Markets? ___________________________________________________________________________ ___________________________________________________________________________ 4.13 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define Transnational Corporations? 2. List the features of Transnational Corporations? 3. What are the Positive impacts of Globalization? 4. State the Negative impacts of Globalization? 5. Give the Meaning of International Capital Market? 6. What are the benefits of International Capital Market? Long Questions: 1. Why are MNCs attracted to developing countries? 2. Why are MNCs good for growth? 3. Explain in detail Intra-firm trade and their benefits of trade liberalization? 91 CU IDOL SELF LEARNING MATERIAL (SLM)
4. Explain the importance of International Capital Market? 5. Discuss the structure of International Capital Market? 6. Explain the major components of International Capital Market? B. Multiple Choice Questions 1. MNC stands for a. Multinational Corporation b. Multination Corporation c. Multinational Cities d. Multinational Council 2. Investment made by MNCs is called a. Investment b. Foreign Trade c. Foreign Investment d. Disinvestment 3. MNCs do not increase a. Competition b. Price war c. Quality d. None of these 4. Multi-National corporations own and manage business in two or more countries called. a. MNC b. FDI c. FII d. Monopoly 5. FDI means (is a controlling ownership in a business enterprise in one country by an entity based in another country) 92 CU IDOL SELF LEARNING MATERIAL (SLM)
a. Foreign development initiatives. b. Various investment policies of the U.S. government. c. A foreign company has an ownership position in a company in another country. d. A type of international negotiation strategy. Answers 1-a, 2-d, 3-d. 4-a, 5-c 4.14 REFERENCES References books G. K. Helleiner, Intra-Firm Trade and the Developing Countries © Gerald K. Helleiner 1981 B O Sodersten and Geoffrey Reed, International Economics, Macmillan Press Ltd., 3rd Edition, 1994. Robert J Carbaugh, International Economics, Thomson – South-Western, 9th Edition, 2004. Textbook references Robert C. Allen, Global Economic History: A Very Short Introduction. Jessie Poon and David L Rigby, International Trade: The Basics, Routledge, 2017 Websites https://www.businessmanagementideas.com/management/multinational- corporation/multinational-corporation/21253 http://www.svtuition.org/2010/05/international-capital market.html https://datahelpdesk.worldbank.org/knowledgebase/articles/114954 93 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 5: TRANSNATIONAL CORPORATIONSANDTHEGLOBALIZATIONPROCES S STRUCTURE 5.0 Learning Objectives 5.1 Introduction 5.2 Valuation of Financial Asset / Financial Liability 5.3 Time of recording Financial Assets transactions 5.4 Offshore Banking 5.5 Personal Offshore Account Vs. Corporate Account 5.6 The Best Way to Structure Your Offshore Bank Account 5.7 Offshore Banking Benefits 5.8 Different Types of Offshore Banking Services 5.9 Summary 5.10 Keywords 5.11 Learning Activity 5.12 Unit End Questions 5.13 References 5.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Explain the International Financial Assets Transactions Determine the Valuation of Financial Assets and Liability Identify the benefits of offshore banking Discuss the Best Way to Structure Your Offshore Bank Account List the types of offshore banking services 5.1INTRODUCTION Meaning of International Asset Transactions
The two broad categories of International Financial Transactions are International Trade and International Asset Transactions. International Asset Transaction is the transfer of the property rights to either real or financial assets between the citizens of one country and the citizens of another country. International Asset Transactions involve the transfer of the property rights to either real or financial assets between the citizens of one country and the citizens of another. It includes activities like buying foreign stocks or selling your house to a foreigner. International asset transactions involve the transfer of owner rights to either real or financial assets between the citizen of one country and a citizen of another country. Types of Transactions Transactions can alter the stock of financial assets or liabilities in a variety of ways, all of which must be accounted for. The following are the more important forms of transactions: 1. Existing assets of all categories can be purchased, bartered, paid in kind, or transferred from other units. From the perspective of the other unit, the same transaction is a disposition of an asset. 2. Transactions in which a creditor advances monies to a debtor frequently result in the creation of new financial claims. The creditor now owns a financial asset, whereas the debtor now owes money. 3. Financial claims are usually resolved through transactions. In rare circumstances, the debtor pays the creditor the funds specified in the financial instrument, resulting in the claim being cancelled. In other circumstances, the debtor purchases its own market instrument. 4. Accrued interest is re-invested in an extra amount of the underlying financial instrument through a transaction. The termination of the financial claim and the sale of an underlying object from which the derivative obtained its value are two transactions that may be included in the settlement of a financial derivative. All transactions that increase a unit’s holdings of assets are labeled acquisitions. All transactions that decrease a unit’s holdings of assets are labeled disposals. Transactions that increase liabilities are referred to as the incurrence of a liability. Transactions that decrease liabilities are variously titled repayments, reductions, redemptions, liquidations, or extinguishments. Thus, the results of transactions in a particular category of financial assets can be presented either as total acquisitions and total disposals or as net acquisitions. Similarly, changes in liabilities can be presented as total incurrences and total reductions or as net incurrences. Transactions that change a category of financial assets are never combined with transactions that change the same category of liabilities. That is, the net acquisition of 95 CU IDOL SELF LEARNING MATERIAL (SLM)
loans would never refer to the increase in loans held as financial assets less the increase of loans as liabilities. 5.2 VALUATION OF FINANCIAL ASSET / FINANCIAL LIABILITY The value of an acquisition or disposal of an existing financial asset or liability is its exchange value. The value of a newly created financial claim is generally the amount advanced by a creditor to a debtor. All service charges, fees, commissions, and similar payments for services provided in carrying out transactions and any taxes payable on transactions are excluded from transactions in financial assets and liabilities. They are expense transactions. In particular, when new securities are marketed by underwriters or other intermediaries as agents for the unit issuing the securities, the securities should be valued at the price paid by the purchasers. The difference between that price and the amount received by the issuing general government unit is a payment for the services of the underwriters. When a security is issued at a discount or premium relative to its contractual redemption value, the transaction should be valued at the amount actually paid for the asset and not the redemption value. Any interest that is prepaid jointly with the acquisition of a security should be treated as accrued interest that had been reinvested in an additional quantity of the security. In this case, the value of the acquisition is the sum of the amount paid for the security directly plus the amount prepaid for accrued interest. It is recognized, however, that interest accruing on deposits and loans may have to follow national practices and be classified under accounts receivable. Not all financial assets have prices as the term is normally understood. Financial assets denominated in purely monetary terms, such as cash and deposits, do not have physical units with which prices can be associated. In such cases, the relevant quantity unit is effectively a unit of the currency itself so that the price per unit is always unity. In the case of nontransferable financial assets, such as some loans, the monetary value is the amount of principal outstanding. Thus, the term “price” has to be used in a broad sense to cover the unitary prices of assets such as cash, deposits, and loans as well as conventional market prices. In some cases, the value of a financial asset is determined by the value of the counterpart to the transaction. For example, the initial value of a loan resulting from a financial lease is the value of the nonfinancial asset leased. The value of an account payable resulting from the purchase of goods or services is the value of the goods acquired or services received. The value of a transaction expressed in a foreign currency is converted to the domestic currency using the midpoint of the buying and selling exchange rates at the time of the transaction. If a transaction expressed in a foreign currency involves the creation of a financial asset or liability, such as accounts payable/receivable, and is followed by a second 96 CU IDOL SELF LEARNING MATERIAL (SLM)
transaction in the same foreign currency that extinguishes the financial asset or liability, then both transactions are valued at the exchange rates effective when each takes place. Government units may acquire or dispose of financial assets on a nonmarket basis as an element of their fiscal policy rather than as a part of their liquidity management. For example, they may lend money at a below-market interest rate or purchase shares of a corporation at an inflated price. Although such transactions involve a transfer component, they are often structured so that the market price is not clear. If the market value can be determined, then the transaction should be valued at that amount and a second transaction should be recorded as an expense to account for the transfer. Otherwise, the value of the transaction should be the amount of funds exchanged. 5.3 TIME OF RECORDING FINANCIAL ASSETS TRANSACTIONS Transactions in financial assets and liabilities are recorded when ownership of the asset changes, when the asset is created or liquidated, or when the addition or reduction in the amount of the financial instrument is made. This time is usually clear when the transaction involves an exchange of existing financial assets or the simultaneous creation or extinction of a financial asset and a liability. In most cases, it will be when the contract is signed or when money or some other financial asset is paid by the creditor to the debtor or repaid by the debtor to the creditor. In some cases, the parties to a transaction may perceive ownership to change on different dates because they acquire the documents evidencing the transaction at different times. This variation usually is caused by the process of check clearing, or the length of time checks are in the mail. The amounts involved in such “float” may be substantial in the case of transferable deposits and other accounts receivable or payable. If there is disagreement on a transaction between two general government units or a government unit and a public corporation, the date on which the creditor records the transaction is the date of record because a financial claim exists up to the point that the payment is cleared and the creditor has control of the funds. When a transaction in a financial asset or liability involves a nonfinancial component, the time of recording is determined by the nonfinancial component. For example, when a sale of goods or services gives rise to a trade credit, the transaction should be recorded when ownership of the goods is transferred or when the service is provided. When a financial lease is created, the loan implicit in the transaction is recorded when control of the fixed asset changes. Some transactions, such as the accrual of interest expense and its borrowing as an additional quantity of the financial instrument, take place continuously. In this case, the transaction in the associated financial asset or liability also takes place continuously. 97 CU IDOL SELF LEARNING MATERIAL (SLM)
Classification of transactions in financial assets and liabilities by type of financial instrument and residence Table 5.1 presents a classification of transactions in financial assets and liabilities based on the type of financial instrument involved in the transaction and the residence of the unit that incurred the liability being held by a general government unit as a financial asset or holds as a financial asset the liability incurred by the general government unit. The units classified by residence are not necessarily the units that were a party to the transaction being recorded. For example, a general government unit might purchase a financial asset in a secondary market from a nonresident, but the asset was originally issued by a resident. Under such circumstances, this instrument would be shown as a domestic instrument even though it was purchased from a nonresident. In addition to normal interest and principal transactions regarding debt liabilities, government units may undertake a range of complex debt-related transactions, such as assuming debt of other units, making payments on behalf of other units, rescheduling debt, debt forgiveness, debt defeasance, and financial leasing. The classifications described do not include functional categories such as direct investment, portfolio investment, or international reserves. Table 5.1Net Acquisition of Financial Assets and Net Incurrence of Liabilities Classified by Financial Instrument and Residence 32 Financial assets 33 Liabilities 321 Domestic 331 Domestic 3212 Currency and deposits 3312 Currency and deposits 3213 Securities other than 3313 Securities other than shares shares 3214 Loans 3314 Loans 3215 Shares and other equity 3315 Shares and other equity (public corporations only) 3216 Insurance technical 3316 Insurance technical reserves [GFS] reserves 98 CU IDOL SELF LEARNING MATERIAL (SLM)
3217 Financial derivatives 3317 Financial derivatives 3218 Other accounts 3318 Other accounts payable receivable 322 Foreign 332 Foreign 3222 Currency and deposits 3322 Currency and deposits 3223 Securities other than 3323 Securities other than shares shares 3224 Loans 3324 Loans 3225 Shares and other equity 3325 Shares and other equity (public corporations only) 3226 Insurance technical 3326 Insurance technical reserves [GFS] reserves 3227 Financial derivatives 3327 Financial derivatives 3228 Other accounts 3328 Other accounts payable receivable 323 Monetary gold and SDRs Classification of transactions in financial assets and liabilities by sector and residence For a full understanding of financial flows and the role they play in government finance, it is often important to know not just what types of liabilities a general government unit uses to finance its activities, but also which sectors are providing the financing. In addition, it is often necessary to analyse financial flows between subsectors of the general government sector. Table 5.2 presents a classification of transactions in financial assets and liabilities based on the sector of the unit that incurred the liability being held by a general government unit as a financial asset or that holds as a financial asset the liability incurred by the general government unit. 99 CU IDOL SELF LEARNING MATERIAL (SLM)
Table 5.2:Net Acquisition of Financial Assets and Net Incurrence of Liabilities Classified by Sector of the Counterparty to the Financial Instrument and Residence In the 1993 SNA, the term “sector” refers to a group of resident units. All nonresident units are referred to collectively as the rest of the world and treated as a pseudo-sector. In the GFS system, it is important to know not only the total amount of financing received from nonresident units, but also the types of nonresident units supplying the financing. In the GFS system, therefore, the classification of “sectors” is applied to nonresident units in the same manner as resident units. In particular, all international organizations are treated as a sector in Table 5.2 For ease of expression, assets will often be used as a reference to both assets and liabilities. If analytically important, other classifications could be introduced. For example, transactions in financial assets and liabilities could be classified by their remaining maturities. The classifications are consistent with the classifications of the same financial assets and liabilities Liabilities in several categories are considered debt, .In addition to normal interest and principal transactions regarding debt liabilities, government units may undertake a range of complex debt-related transactions, such as assuming debt of other units, making payments on behalf of other units, rescheduling debt, debt forgiveness, debt defeasance, and financial leasing. Transactions in monetary gold can only take place between two monetary authorities or between a monetary authority and an international financial institution. If the monetary authority adds to its holdings of monetary gold by acquiring either newly mined gold or 100 CU IDOL SELF LEARNING MATERIAL (SLM)
Search
Read the Text Version
- 1
- 2
- 3
- 4
- 5
- 6
- 7
- 8
- 9
- 10
- 11
- 12
- 13
- 14
- 15
- 16
- 17
- 18
- 19
- 20
- 21
- 22
- 23
- 24
- 25
- 26
- 27
- 28
- 29
- 30
- 31
- 32
- 33
- 34
- 35
- 36
- 37
- 38
- 39
- 40
- 41
- 42
- 43
- 44
- 45
- 46
- 47
- 48
- 49
- 50
- 51
- 52
- 53
- 54
- 55
- 56
- 57
- 58
- 59
- 60
- 61
- 62
- 63
- 64
- 65
- 66
- 67
- 68
- 69
- 70
- 71
- 72
- 73
- 74
- 75
- 76
- 77
- 78
- 79
- 80
- 81
- 82
- 83
- 84
- 85
- 86
- 87
- 88
- 89
- 90
- 91
- 92
- 93
- 94
- 95
- 96
- 97
- 98
- 99
- 100
- 101
- 102
- 103
- 104
- 105
- 106
- 107
- 108
- 109
- 110
- 111
- 112
- 113
- 114
- 115
- 116
- 117
- 118
- 119
- 120
- 121
- 122
- 123
- 124
- 125
- 126
- 127
- 128
- 129
- 130
- 131
- 132
- 133
- 134
- 135
- 136
- 137
- 138
- 139
- 140
- 141
- 142
- 143
- 144
- 145
- 146
- 147
- 148
- 149
- 150
- 151
- 152
- 153
- 154
- 155
- 156
- 157
- 158
- 159
- 160
- 161
- 162
- 163
- 164
- 165
- 166
- 167
- 168
- 169
- 170
- 171
- 172
- 173
- 174
- 175
- 176
- 177
- 178
- 179
- 180
- 181
- 182
- 183
- 184
- 185
- 186
- 187
- 188
- 189
- 190
- 191
- 192
- 193
- 194
- 195
- 196
- 197
- 198
- 199
- 200
- 201
- 202
- 203
- 204
- 205
- 206
- 207
- 208
- 209
- 210
- 211
- 212
- 213
- 214
- 215
- 216
- 217
- 218
- 219
- 220
- 221
- 222
- 223
- 224
- 225
- 226
- 227
- 228
- 229
- 230
- 231
- 232
- 233
- 234
- 235
- 236
- 237
- 238
- 239
- 240
- 241
- 242
- 243
- 244
- 245
- 246
- 247
- 248
- 249
- 250
- 251
- 252
- 253
- 254
- 255
- 256
- 257
- 258
- 259
- 260
- 261
- 262
- 263
- 264
- 265
- 266
- 267
- 268
- 269
- 270
- 271
- 272
- 273
- 274
- 275
- 276
- 277
- 278
- 279
- 280
- 281
- 282
- 283
- 284
- 285
- 286
- 287
- 288
- 289
- 290
- 291
- 292
- 293
- 294
- 295
- 296
