BALANCE OF PAYMENT DISEQUILIBRIUM

A nation's balance of payment is said to be in equilibrium when it is neither drawing upon its international reserves to make excess payments nor accumulating such reserves as a result of its receipts. In other words, when a country is not able to pay for its imports of goods and services from its export earnings, on accumulating reserves year after year, disequilibrium in balance of payments sets in. Policy initiatives are needed to restore equilibrium.

Disequilibrium in balance of payment may be short term or long term in nature. Short term disequilibrium, arises largely on account of cyclical factors. A crop failure leading to a sudden fall in export earnings may create a shortfall and consequently disequilibrium. 

Long term or structural disequilibrium arises on account of long term structural changes in the economy. Fall in demand of export products due to technological changes may bring about a decline in export proceeds. Decline in demand and prices for natural rubber on account of development of synthetics may be cited as an example. Such a situation call is remedied only by diversification of economy.

DEFICIT AND SURPLUS IN BALANCE OF PAYMENTS

You have learnt that BOP accounting is based on the principles of double entry book- keeping, meaning thereby that for every credit entry, there is a debit entry. Thus, a BOP account always balances. The difference between aggregate debit and credits is called balance. In case, debits exceed credit, balance is negative or deficit, when the credits exceed debits, the balance is positive or surplus. Obviously, the term, deficits or surplus cannot then refer to the entire BOP but sub set of accounts included in BOP. 

Where value of exports exceeds imports, the situation is referred as trade surplus or surplus on trade account. Excess of imports over exports results in trade deficit on trade account. 

The transactions appearing in a balance of payments can be classified in two categories, via autonomous transactions and accommodating or financing transactions, Autonomous transactions take place on their own, in response to their felt needs and are independent of situation in the balance of payments. Accommodating or financing transactions refer to the flows which take place in response to surplus or deficit in the balance of payments. For example, a country may incur or raise its liabilities or reduce its assets in order to pay for the deficit. A deficit in balance of payment exists when payments for autonomous or self motivated transactions exceed receipts. In case, there is a deficit or surplus, there have to be some compensatory transactions to balance the imbalance.

Autonomous and financing transactions are also referred to as above the line ad below the line respectively. 

There are several concepts of ‘balance’ in balance of payments. These are: 

Trade Balance: This is the balance on the merchandise trade account, i.e. Item 1 in the current account. 

Balance on goods and services: This is the balance between the export and import of goods and services. It is the net balance on item I and sub-items 1-6 of item III taken together. 

Current Account balance: This is the net balance on the entire current account items I+ll+IlI. When it is negative we have a current account deficit, when positive, a current account surplus. 

Balance on current account and long term capital: This is also called basic balance. This is supposed to indicate the long term trends in BOP. 

While changes in reserve assets are accurately measured, recording of other items is subject to errors arising out of data inadequacies, discrepancies of valuation and timing, erroneous reporting etc. These are reconciled through a fictitious head of account called 'Errors and Omissions'.

Modern Theory of Trade

The contemporary theories of trade deviate from the assumptions of perfect competition and constant returns to scale made both in the classical and the neoclassical models. In the modern theories the market structure is either monopolistic or oligopolistic. In the former case a large number of producers produce goods that are not identical but differentiated in quality or design. In the latter case only a few producers serve the market with either identical products or differentiated products. The products which are just differentiated horizontally are similar in quality but different in design, like a red pen and a blue pen, white wine and red wine or wooden furniture and steel furniture. Vertical product differentiation involves quality differences as in small cars and large cars, lf the products are horizontally differentiated they are produced by more or less the same technology. Vertical product differentiation would. Invariably mean that the technology varies with quality or type of the product.

The modem theories assume economy of scale in production. An example of economy of scale is shown in the following Table:

One may easily check that the technology described above is a departure from the constant returns to scale we have been using so far. For example the output is doubled from 1 to 2 as labour is less than doubled from 3 to 5. Suppose that there are two similar goods, A and B being produced by the above technology, the economy has 10 units of labour. The consumers will consume the two goods in 1:1 proportion. Therefore the labour force will have to be equally divided in the production of the two goods and 2 units each of A and B will be produced and consumed in the economy. Now suppose there is another economy with the same technology to produce A and B having 10 units of labour. Then it is quite easy to see that one economy produces only A and the other produces only B and then trade with each other then the consumers in each country will be able to consume 3.5 units each of A and B and be better off than autarky. This is an example of trade taking place between two countries having the same technology and factor endowments simply due to economy of scale. But there is difference in the nature of trade. In the earlier models the products were different and produced by different technologies and the trade was between two industries, such as one country exporting cloth and importing wheat. This kind of trade is called inter-industry trade. But in the contemporary models trade is intra-industry, i.e., in the same industry located in two different countries. It is like one country exporting white wine and importing red wine - both goods requiring the same technology as in the above example. It turns out that a very substantial part of world trade is intra-industry in nature which shows the importance of modern theories in the contemporary world.

THEORIES OF INTERNATIONAL TRADE: INTRODUCTION & OBJECTIVES

INTRODUCTION OF TRADE THEORIES

Foreign trade has recently, and particularly after 1991, become an important as well as debatable issue for the Indian economy. The Union budget presented in 1991 introduced a wide range of economic policy reforms related with industry and trade, ushering in an era of economic liberalism in the Indian economy. These reforms were designed to transform a closed and inward-looking economy into an open and outward-looking one by lifting controls on  import  and export of goods and services and by  making rupee convertible. In the years that followed, our trade and industrial production have been growing at fairly high rates.  There is no doubt that the liberal approach to economic policy will continue and the previous bias against international trade and investment will remain subdued in the foreseeable future.  In this new economic environment the, teaching of economics will develop a serious gap if the students are not made aware of the basic principles and concepts of international trade. 

OBJECTIVES OF TRADE THEORIES

The purpose of a trade theory is to explain the pattern of trade between two countries.  What is meant by pattern of trade? Suppose India exports garments, gems and jewellery and a few other products to the United States, while the latter exports computer parts, such as hard disks, and other machines to India. This pattern of export and import of goods is known as the pattern of trade. The theory of international trade explains why such a pattern emerges and lists the factors which cause such a pattern. Trade between two nations is not just in goods. Trade in services is also quite important. If the United States provides banking and insurance services to the Indian citizens, say to the Indian exporters and importers, and if these services are provided from the United States, then it is to be regarded as the U.S.  Export of services to India. There are two main theories on pattern of trade: the classical or the Ricardian theory and the neoclassical theory or the Heckscher-Ohlin-Samuelson theory.

The second objective of trade theory is to explain the pattern of specialization. A pattern of specialization tells us the kinds of products and their quantities a country would produce. In the above example, India would produce garments, gems and jewellery and other products and the United States would produce computer parts and other machines. India may or may not produce computer parts and machines which USA would produce and similarly USA may or may not produce garments and the gems and jewellery. The pattern of trade and the pattern of specialization will depend on the model you are using to explain these patterns. If you are using the Ricardian theory then you come to the conclusion that USA would not produce garments or gems and jewellery in which India has specialized. But if you are using the neoclassical theory then you would say that USA would produce the goods it is importing from India. The domestic industries that produce the goods that the country imports are known as import competing industries (e.g.  Garments for USA computer parts for India) and those producing goods that the country exports are called export industries (e.g.  Computer parts for USA and garments for India). A country however will have industries whose products are neither exported nor imported and the goods produced by them are called non traded goods, such as domestic transportation, electricity, etc.

The third objective of trade theory is to show that international trade is mutually beneficial to the trading countries. A country which is not engaged in trade with any country is in a state of autarky. The theory says that trade is better than autarky under any circumstances. However, how much trade a country should have and whether a country should restrict the quantities of exports and imports by customs duties, tariffs, quotas and taxes is quite another matter.

ECOLOGICAL ENVIRONMENT

Ecology refers to the pattern and balance of relationships between plants.  Animals, people and their environment. Earlier there was hardly any concern for the depletion of resources and pollution of the environment. Smoke stemming from the chimneys and the dust and grime associated with factories were accepted as a necessary price to be paid for the development.  But  in recent years, the magnitude and nature of the  'pollution  overload'  have assumed such  alarming proportions that pressures have built  up  all  over the world to  do something urgently  lest the  situation gets out of control. In almost all the countries, there exist today legislation and codes of conduct to preserve the earth’s scarce resources and put a halt to any further deterioration in the environment. Business operations of the international firms are no exceptions and have been brought under such regulations. Very recently, the United States government imposed a ban on exports of marine products from countries including India which did not have special devices fitted into fishing trawlers to free the tortoises trapped during fishing expeditions. Similarly, restrictions have been put on garment exports using cloth processed through the use of AZO dyes. Germany today is perhaps the country with most stringent environmental laws in the world.

The concept of industrial progress and development has also undergone paradigm shifts. Corporations today are judged in terms of not only financial returns, but also conservation of environmental resources and reduction in pollution levels. Green technologies, green products and green companies are highly valued in today’s global market place.

POLITICAL ENVIRONMENT

It is rightly said that a foreign business firm operates only as a guest and at the convenience of the host country government. The government reserves the right of allowing a foreign firm to operate in the country as well as laying down the manner in which a foreign firm can conduct business. To gain  an  insight into a foreign  country's political environment, one needs to  analyze factors such as current form of government and political party system, role of government in  the economy, political encouragement to foreign firms, political stability, and  political risks to  business.

Form of Government and Political Party System: Government in a foreign country can be either parliamentary or absolutist. While the parliamentary type of government is run by people's representatives selected from time to time, the absolutist government assumes the form of absolute monarchies or dictatorships, and only a select few make policies. In the case of parliamentary government, one needs to know whether it is a single party system or multiparty government system. Single party government is considered to be more stable than the multiparty government.

Political Ideology and Role of Government:  Besides political party system, one must have knowledge about the political ideology and government attitudes toward foreign business and investment. In addition to regulatory role, government itself can be directly involved in business. In such cases, government enterprises emerge as dominant players in the market and pose tough competition to the foreign firms. Even supplying goods and services to the government agencies is not hassle free. Because of monopsonic power of the government organizations, it becomes quite arduous to negotiate prices and other terms with them.

Political Stability:  Stability of the government and government policies are a major concern for the international firm. Since business decisions, these days involve huge investments and are irreversible, what the foreign firms look in for is politically stable countries. Political instability can result from either change in the type of government, a shift in-political parties that form the government or change in the government policies without change in the government or shifts in political parties.

Political Risk: Political risk which is defined as the vulnerability of a project to the political acts of a sovereign government is a big threat to foreign business. The political acts leading to political risks can range from confiscation, expropriation, nationalization, domestication to restrictions on transfer of finds. Confiscation occurs when a foreign investment is taken over by a government without any compensation. Expropriation takes place when the, government takes over foreign investment but some compensation is paid. The compensation may or may not equate with the market value of a firm. Nationalization affects the entire industry rather than a single company, and involves transferring ownership of the confiscated or expropriated business to a national firm or government entity.

Domestication is a mild form of intervention and involves transfer of control of foreign investment to national ownership to bring the firm's activities in line with national interest. It differs from expropriation in the sense that it is gradual encroachment of the freedom of operation of a foreign operator. Domestication can be either firm initiated, government initiated or predetermined. Whereas firm initiated and predetermined domestication entail low levels of risk, government initiated domestication is quite risky and is ranked with expropriation.

Another type of risk relates to a temporary or permanent blocking of finds.  Unlike other kinds of risks, a business firm under blockage of funds owns the funds and property rights but it cannot remit the funds or earnings back to home country. This was a common problem faced by Indians during Amin’s rule in Uganda, although the government did not formally make any announcements regarding takeover of property, it became almost impossible for the firms to repatriate their earnings in any form. No doubt black money market operations may exist in any country; it is difficult for such operations to handle large scale of funds involved.

International firms need a proactive approach to deal with political risks.  An effective management of risks calls for recognizing the existence of various kinds of political types of risks and their consequences, and developing appropriate plans and policies to deal with such risks.

SOCIO-CULTURAL ENVIRONMENT

Business is as much a socio-cultural phenomenon as it is an economic activity. Per capita income in two countries may be the same, yet the consumption patterns in these countries may differ. Socio cultural forces have considerable impact on products people consume; designs, colour and symbols they like; dresses they wear and emphasis the place of religion, work, entertainment, family and other social relations. Socio-cultural environment influences all aspects of human behavior and is pervasive in all facets of business operations.

Culture can be defined as a "sum  total of man's  knowledge, beliefs, art, morals, laws, customs and  any other capabilities and habits acquired by man  as a member of society."  It is a distinctive way of life of group of people, their complete design of living. Culture thus refers to a man's entire social heritage - a distinctive life style of a society and its total value system which is intricately related to be consumption pattern of the people and management philosophies and practices.

Furthermore, within each culture there are many subcultures that can have business significance. For instance, in a country like United States distinct subcultures prevail in the South, North-Eastern or Midwestern parts. Subcultures are found in all national cultures and failure to recognize them may create impressions of sameness which in reality may not exist. A single national and political boundary does not necessarily mean a single cultural entity. Canada, for instance, is divided between its French and English heritages, although politically the country is one. Because of such distinctive cultural division, a successful marketing strategy among the French Canadians might not effectively work among the English Canadians or vice-versa. Similarly a single personnel policy may not work with workers employed in two different plants if they belong to different sub cultural groups and differ in their work habits and underlying motivations.

Elements of Culture

Some of the important elements to understand a country's culture are: language, aesthetics, education, religions and superstitions, attitudes and values, material culture, social groups and organizations, and business customs and practices.

Language: Language is an important element of culture and it is through language that most of the communications take place. An international marketer should have a thorough under- standing of the language of the market - particularly the semantic differentials and idiomatic nuances which are essential characteristics of all languages of the world. Dictionary translation could be quite different from the idiomatic interpretation of a language. When literal translations are made of brand names or advertising messages from one language to another by people who know the language but not the culture, serious mistakes may occur. When General Motors of the United States literally translated its marketing phrase ‘Body by Fisher’ into Flemish language, it meant ‘Corpse by Fisher'.  Similarly, the phrase "Come alive with Pepsi" faced problems when it was translated into German advertisements as "Come out of grave" or in Chinese as "Pepsi brings your ancestors back from the grave". When the American car called ‘Nova’ was introduced in Puerto Rico, sales were poor until the company realized that the word Nova was pronounced as ‘Nova’ - which literally meant in Spanish "does not go".  Sales were better when the name was changed to 'Carbie'.

Aesthetics:  Aesthetics pertain to a culture's sense of beauty and good taste, and is expressed in arts, drama, music, folklore, dance and the like. Aesthetics are of special interest to the international business executives for these govern the norms of beauty in a society and are helpful in correctly interpreting meanings of various methods of artistic expressions, colours, shapes, forms and symbols in a particular culture. Colours, for instance, mean different things to different people. The colour of mourning is black in the United States, but it is white in the Far East. Green is restful colour to Americans, but it is disliked by people in Malaysia where it connotes illness and death. Symbols also need to be interpreted correctly, Seven, for instance, signifies good luck in the United  States but just  opposite in Singapore, Ghana and  Kenya. Use of number four should be avoided in Japan because it is pronounced as ‘shi’ which in Japanese means death. Sensitivity to the aesthetics of a society and their symbolic expressions can greatly help in avoiding socially embarrassing situations and correctly designing the products and messages.

Education:  Education is generally understood as formal schooling. But it is better to adopt a broader perspective and define education as any process, formal or informal, through which one learns skills, ideas and attitudes. Education is important as it affects not only the education levels but also the development of mental faculties and various skills, In general, educated people have been found to be more sophisticated, discriminating and receptive to new products and ideas. Availability of educated manpower like skilled labour, technicians and professional is also dependent on the country’s education level. Media to be used by a company for promoting its products as services are also dependent on education level prevailing in the country. The conventional forms of printed communications, for instance, do not work in countries where literacy rates are low.

Religions and Superstitions:  Religions are a major determinant of moral and ethical values and influence people’s attitudes, habits and outlook on life which are reflected in their work habits and consumption patterns. Dr.  Ernest Dichter observed: "In puritanical cultures, it is customary to think cleanliness as being next to godliness. But in Catholic and Latin American countries, to fool too much with one's body to overindulge in bathing or toiletries, has the opposite meaning. It is that type of behavior which is considered immoral and improper". There are numerous religions and faiths in the world, with prominent ones being: Animism, Buddhism, Christianity, Hinduism, Islam and Shinto. Each one has its own morals and codes of conduct. A working knowledge of the religions prevalent in the target markets helps in understanding people's work habits, underlying motivations and consumption behaviors. Equally important are the superstitions of the people in a society.  People’s beliefs in astrology, hand reading, ghosts, lucky days and places are integral part of certain cultures. In some countries, single storey houses are preferred because it is considered bad to have another's foot on one’s head. Location of a building and its architecture in many Asian countries is governed by the principles of ‘vastushastra’ rather than purely geographical and economic considerations.

Attitudes and Values: Besides religions and superstitions, one must be cognizant of attitudes, values and beliefs prevalent in a society. These attitudes and values may relate to consumption level, material possessions, risk taking and change. ‘What is important and desirable' differs from society to society and is largely governed by the attitudes and value existing in a society. Americans in general are more receptive to change and risk taking, but people in many societies are averse to change and risk taking. They prefer doing what is traditional and safe. New products are not accepted unless these have the approval of local chiefs or religious leaders.

Material Culture:  According to Ball and McCulloch, material culture refers to all manmade objects and its study is concerned with how man makes things and who makes what and why. While the question 'how it relates to technology, other questions ‘that’, ‘what’ and ‘why’ are part of economics.

Technology includes the ways and means applied in making of material goods. It is technical know-how in possession of the people of a society. Choice of technology has its repercussions to the size of investment, scale of operations as well as type and amber of workers to be employed. Technology transfer has been a highly controversial issue in the past. Because of supply of obsolete or inappropriate technology, many developing countries have laid down stringent rules and regulations concerning technology imports and payments. Since transfer of new technology is often riddled with workers’ resistance to change and public criticisms, multinational corporations are advised to have suitable action plans to counter such opposition. Economic aspects of material culture, i.e., who, what and why, have already been discussed before.  It is suffice to say here that these elements influence the level of demand as well as types and quality of goods in demand, and consumption pattern in a society. Business implications of material culture of a society are obviously many. The goods and services that are acceptable in one market may not be acceptable in another market because of differences in material cultures of two societies. For example, sophisticated electronic appliances widely in demand in the technologically and economically advanced Western countries may not find a market in the less developed countries of Asia, Africa or Latin America.

Social Groups and Organizations: A study of social groups and organizations is important as it determines how people relate to one another and organize their activities. The size and cohesiveness of the family, role of men and women in society, and positions of different social classes differ from country to country. Social groups and organizations mould the pattern of living and interpersonal relationships of people in a society. They influence the behavioral norms, codes of social conduct, value systems, etc., that may be of relevance to the international business managers in their decision making.

Business Customs and Practices:  A familiarity with business customs and practices prevalent in different countries is a must to avoid business blunders. An international business manager must have necessary knowledge about how business is conducted and what importance business people in a foreign country attach to work, time, formality, change and achievement. American managers, for instance, are by nature highly work oriented and attach upmost importance to speed and punctuality in business dealings. They are, moreover, highly achievement oriented and fond of new things. But people in other parts of the world do not share these values and beliefs. Japanese, for instance, are also workaholics but they are very slow in decision making Latin Americans too do not believe in haste and spend considerable time in socializing and developing friendships before coming to business transactions.

A  person  dealing with people from different cultures should  be well aware of differences in the number and nature of stages  involved  in  business negotiations  anal  formalities to be observed  in  concluding business  contracts. While  in  countries like the United  States it is necessary to have final  agreement in  writing, this practice  is  not  much appreciated  in  many West Asian  countries where oral agreement  alone is considered more  than  sufficient.

ECONOMIC AND FINANCIAL ENVIRONMENT

Among the entire uncontrollables, economic environment is perhaps the most important factor. An analysis of economic environment enables a firm to know how big the market and what its nature is. Answers to these questions in  turn  determine  whether  a firm should enter a given  foreign market,  and if  yes, what strategies it should use to successfully run  its business operations, Closely related to the economic environment is the financial environment which  affects a firm's capital structure, investment decisions  and  accounting practices.

Various dimensions one needs to consider while attempting an economic and financial analysis include: foreign country’s level of economic development, income, expenditure pattern, infrastructure including financial institutions and system, inflation, foreign investment in the country, commercial policy, balance of payments account, accounting systems and practices, and integration of the foreign country’s foreign exchange, money and capital markets with the rest of the world. Let us learn this economic and financial environment in detail.

Economic Environment

Economic environment is the most important indicator of the global market analysis. Let us discuss the major economic indicator influencing the foreign market decisions.

Economic Development: Economic development is directly related to the development of marketing in a country. Countries characterized by high levels of economic development not only have high demand for a variety of products, but also have better infrastructure and more developed marketing systems. Competition is also high in these countries. In the less developed countries, on the other hand, not only demand is low, but infrastructure is also poor. It, therefore, becomes quite difficult and more expensive to do business in such nations.

Income:  Income is an important indicator of the country’s level of development and also its market size. Gross national product (GNP) and per capita income are among the major measures of income.  While sales of most of the industrial goods and capital equipment generally correlate with GNP, demand for consumer products depends on per capita income.

Besides income, one should acquire information about the sectoral distribution of the GNP as it is an important determinant of kinds of goods in demand in a foreign country. If the majority of a country’s GNP comes from agriculture, it implies that the country is agriculture based and it shall have a good demand for agricultural inputs such as seeds, fertilizers, pesticides and agricultural machinery and tools. An industrial nation with relatively higher dependence on manufacturing, on the other hand, shall have a good market for raw materials, plant and machinery, and also for a variety of consumer durables and non-durables.

Though per capita income is a useful measure, it is not a full-proof measure of the country's development and prosperity. What is more relevant is the distribution of income. While in the developed countries income distribution is relatively more even, it is highly skewed in the developing countries. Since only a small portion of the population accounts for 60 to 70 per cent of the country’s GNP and the rest are poor in the developing countries, market for high priced product and non-essential products is limited only to select rich people.

Expenditure Pattern:  Data on expenditure patterns are useful in judging as to how the money is spent on different item and which products receive more weight age.

Infrastructure: Infrastructure is another vital dimension of the country’s economic environment and is directly related to the country’s economic development. Infrastructure refers to various social overheads such as transportation, telecommunications, commercial and financial services like advertising, marketing research, various media, warehousing, insurance, and distribution, credit and banking facilities.  Absence of adequate infrastructure not only hinders country’s development but also affects firms’ costs and capacity to reach various market segments. Companies find it difficult to co-ordinate and control their business in countries with poor communication systems.

Financial Environment

Sound financial positions of the country coupled by the favorable investment policies reflect strong demand potential.  Let us briefly learn important financial indicators.

Monetary and Fiscal Policies:  Inflation, interest rate, various kinds of duties and exchange rates are the variables related  to the country's monetary and fiscal policies and have a substantial impact on the costs and profitability of business operations. These variables also influence firm's decision to move funds from one nation to another.

Commercial and Foreign Investment Policies: Each country has its own commercial and foreign investment policies which must be studied in detail to ascertain country’s openness to trade and investment with other countries. A proper understanding of these policies can be quite helpful in ascertaining what tariff and non-tariff barriers the particular country uses to protect its domestic industry from foreign competition. The country may plan to minimize the incidence of these trade measures.

Balance of Payments Account: A country's balance of payments account is another major source of information about the country’s foreign trade and foreign currency reserves. The current account throws light on the country’s exports and imports as well as its major sources of imports and destinations of exports.  Capital account reveals stocks of foreign investments, borrowings, lending and foreign exchange reserves. An international firm must be duly aware of exchange controls prevalent in the foreign countries. Countries running deficit in their balance of payment accounts generally impose controls on movement of foreign exchange into and out of their economies. These controls prompts the multinational corporations to resort to transfer pricing mechanism,  i.e.,  over invoicing  of imports and under pricing of exports so as to move out more than permitted finds from such countries.

GEOGRAPHIC ENVIRONMENT

Geography is an important component of the foreign environment and refers to a country's climate, topography, natural resources and people.  Everyone engaged in international business must have some knowledge of geographic features of the foreign country as these influence the nature and characteristics of a society. It also affect demand pattern of the people living in the country.  Geography is a major contributory factor to the development of business systems, trade centers and routes.

Different climatic conditions (viz., rain, snowfall, wind, temperature, humidity, etc.,) give rise to demand for different types of products. It is largely due to climatic differences that people differ in their housing, clothing, and food, medical and recreational needs.  Many a time needs are same, and the same products are demanded. But because of the climatic and topographic differences, products need adaptation or modifications to suit local conditions. Rolls Royce cars from England, for instance, required extensive body  work and  renovations in  Canada  because the  salted sand, spread  over streets to keep them  passable throughout four or five months of virtually continuous snow in  Canada, caused  rusting and corrosion in  the fenders and door panels and  oil system also developed  leaks.

Geographic conditions also affect a firm’s plant location decision.  A  firm prefers to set up its manufacturing plant  in  a  country which  has favorable climatic  conditions, possesses suitable topography  (i.e.,  surface features  such as hills, plains, river  and  sea) and  where raw materials, energy and  labour are cheaply  and  abundantly  available. Foreign country’s nearness to other markets and its strategic location on major trade routes are other equally important considerations.

Firms'  distribution and logistics strategies are directly  influenced by  geographic  conditions in the foreign markets,  Re-order points  and safely level stocks are kept generally higher for those countries  or places which are not easily accessible  and  can be  cut off suddenly and heavily due to bad  weather. Location of a country on the world map is an equally important consideration. It affects its trade prospects with other countries.  Landlocked  countries such as Bolivia, Zambia and Zimbabwe ,are not only costly to reach  but are also difficult  to penetrate as trading with these countries depend  upon  their relations  with neighboring  countries through  which goods have to cross.

Consumer demand for many a low priced and essential product is directly related to the number of people living in a country. It is primarily due to large populations that  the countries  like China and  India  have  become  the targets of the  multinational  corporations which are vying with one another to gain  a foothold  in these markets. To arrive at a correct estimate  of the market size, however, one needs to take into account other factors also such as population  growth, population  density and population distribution  by age, income, location and  occupation, taken together, these variables provide better estimates of the present  and future market  potentials  and also help  in  providing information  relevant for communication,  distribution,  product  quality  and pricing  decisions.

THE COMPONENTS OF FOREIGN ENVIRONMENT

All the three types of environments, viz., domestic, foreign 'and global environments have their effects on international business operations.  Because of the vastness of subject, it is not possible to discuss all the three types of environments and their impact on business in one unit.  The present unit, therefore, confines itself to a discussion of various components of foreign environment. The other two types of environments and their business influences are examined in detail in other units. Foreign environment was described, in the preceding section as consisting of geographical, economic, financial, socio-cultural, political, legal and ecological forces.  A firm needs to examine these components of the environment for each one of the foreign countries in which it operates.  A brief description of these components and their influence on the firm's international business operations is provided in the following sub-sections. Though ‘we shall be discussing each of the components separately, in reality there exists a lot of overlapping as well as interactions among various components.  Population, for instance, is discussed in literature as, an element of both the physical and economic environments.  There is a lot of overlapping among the socio-cultural, legal and political forces. Geographic characteristics of a country have profound impact on the country's economic and socio-cultural environments.

Moreover, it should be kept in mind that all the components-and elements of the environment might not be relevant to a decision maker.  Much depends on the nature of the firm and its decisions. For a small firm interested in exporting, analysis of the commercial policy and the economic environment would be sufficient. But for a multinational corporation interested in setting up a manufacturing plant in a foreign country, geographic as well as socio-cultural, legal and political environments would be as important as the economic environment.

Relevance of International Business Environment

As stated earlier, environment plays a vital role in the conduct of business operations. Especially in the context of international business, environment assumes critical importance as no two countries have similar environments and demand different business strategies to cope with differing business conditions.  As the environment affects firms’ strategic as well as tactical decisions, it becomes imperative for the firm to have in-depth knowledge of the domestic, foreign and global environments.

When a firm decides to enter into international business, it faces two major decision problems: one, in which market(s) to select, and second how to enter into those markets.  Both these decisions are strategic in nature and are greatly influenced by the environmental forces.  Firms select those countries as their target markets which have sufficient market potential.  Market potential in turn depends upon geographic, economic and cultural environments prevailing in the foreign countries.  Demand for fans, for instance, will be more in countries which are geographically located in hot zones and where per capita income is high enough for the people to afford purchase of fans. Besides climate and sufficient income, electricity should be available to make the fans workable.

Once the firm identifies countries with market potentials, it needs to decide as to what mode it should use for entering into those markets.  A wide range of options such as exporting, licensing, franchising, joint venture or setting up wholly owned subsidiaries abroad are available to firms.  Firm’s actual choice of market entry mode is influenced by a variety of environmental factors.  Exporting is desirable when it is economical to produce in the home country and there are no legal restrictions on import of given product in the foreign markets.  In the case of import bans or excessive costs of transportation, a firm may choose to set up its manufacturing and marketing subsidiaries abroad.  But this is feasible only when foreign governments are not averse to foreign direct investment, and necessary raw materials and labour are available locally at competitive prices in the foreign countries. In countries where first condition is not fulfilled, the firm can go in for either licensing or joint venture as these entry modes are politically less objectionable.

Environmental forces play an equally important role in shaping a firm’s functional and tactical decisions.  What should be the scale of production?  Should the firm employ labour or capital intensive techniques?  How to finance firm are foreign operations?  How much to repatriate?  What marketing mix should the firm use? Should it hire local persons or employ foreign nationals? What should be their compensation package?  Answers to these and other questions require in-depth analysis of the prevailing environments in foreign countries.  Since the environments differ, firm cannot be much successful by falling back upon its domestic decisions and practices. Firm needs to screen the foreign country environments and accordingly decide about the best course of action in each country.

It may be pointed out here that environmental analysis is important not only for the firms entering into the foreign markets for the first time, but it is also important for the firms already in international business.  Since environmental conditions change over time, firms need to continuously monitor changes in the environment and make suitable changes in their decisions.