Economic Context of International Business - Assignment Example

Economic context of international business Student’s Name University affiliation Part A Historical volatility existing in agricultural commodity market results from market failure in terms of both supply and demand-sides. This essay will explore the problem by identifying leading elements in supply-side and those from demand-side. Additionally, the essay will also discuss the mechanisms available for governments and business to manage price movements. Notably, countless factors influence variation of price level of agricultural commodities at local, national, regional, and international markets. The factors affiliated with supply shocks, which are briefly discussed in this sub-section, include climate change and public policy. a. Climate variability From an historical perspective, this has been the most recurrent factor influencing agricultural price volatility. Since time immemorial, agricultural production has been based on prevailing weather conditions. Supply shocks mostly occur during times of extreme weather events. Because of geographical and temporal spacing of such events, times of high volatility tend to be limited to certain products, seasons, and regions. Volatility is inherent in agricultural commodity prices because the sector is subject to vagaries of climate (Chambers & Quiggin, 2003: 336). In recent decades, effect of the increased climate variability has led to catastrophes, such as floods, droughts, famines, and floods. Ideally, climate change has presented an immense global challenge, which is directly related to prices of agricultural commodities. b. Public policy Public policy greatly influences supply of agricultural products and ultimately, the price levels. New public policies at national level can result in withholding inventory or raising export tariff. Such decisions will result in changes in levels of commodity supply at national, regional, and international levels. When export tariff is raised, many exporters may abandon the business leading to increased supply in local markets. Coincidentally, such decisions will lead to decreased supply in the international markets leading to increasing price levels. Increasing export tariff was implemented by many countries during the food crisis of 2007-2008 (Chambers & Quiggin, 2003: 337). The factors affiliated with demand shocks, which are briefly discussed in this sub-section, include change in income, new uses of agricultural products, integration of agriculture with other industries, and effect on foreign exchange. a. Change in income Upward trends in income may affect level of demand, especially for poorest section of population who devote a huge junk of their incomes to purchasing foodstuff. Sharp drop in income can result in economic crisis at individual level, leading to reduction in purchasing power. b. New uses for agricultural products Discovery of new uses of agricultural products may be driven by technological, ideological, or social changes. When new uses are discovered, a short-term pressure is felt on demand side. For instance, discovery of juicing led to increased demand for various fruits for processing (Chambers & Quiggin, 2003 p. 346). Under such circumstances, demand for certain commodities increases leading to price changes. c. Integration of agriculture with other industries In the recent years, volatility of prices of agricultural commodities has been partly caused by integration with other markets, such as fuel markets and financial markets. Technology made it possible to use agricultural products to produce biofuels, such as biodiesel and ethanol. Because of that, volatility in prices of biofuels is transferred to agricultural sector because it supports its production. It has also been noted that expansion of financial sector has led to diversification and deregulation, which has enabled investment flows into many countries (ECLAC, 2008: 187). In the past, financial sector did not support agriculture because of high risk-levels. However, with the use of technology and effective government policies, many financial agents have invested in agriculture, leading to increased food supply in global markets. d. Effect on foreign exchange Foreign exchange affects volatility of international prices because agricultural products are usually denominated in U.S. Dollars. If other factors are kept constant, price volatility can still be witnessed subject to depreciation or appreciation of home-currency against the dollar. Recently, the dollar depreciated against many world currencies, leading to increased international prices of commodities denominated in the U.S. dollar (Chambers & Quiggin, 2003: 337). Numerous mechanisms are available for governments and business to manage price movements. Some of them include hedging with future price-contingent contracts, insurance, adoption of holistic approach to risk management, training, and concentration on catastrophic risks. i. Hedging with future price-contingent contracts Both governments and businesses should take a step of formulating and implementing strategies for assisting farmers to reduce risks faced in production of agricultural commodities. Agricultural markets commonly face price volatility because of biological lags experienced during production (Arias & Harri, 2000: 89). By creating simple market instruments, future prices could be hedged to protect the farmers and consumers. ii. Insurance With increased climatic challenges, governments and business community should make it possible to integrate insurance and agricultural sectors. Livestock production and crop yields are sensitive to weather conditions. Although crop insurance exists in many countries, it depends majorly on government support (Glauber, 2004: 1179). Workable regulations could be applied to expand the scope and functionality of such undertakings. iii. Holistic approach to risk management Policies embraced by both the government and private sector need to be holistic in nature. In other words, the process of formulating policies should consider assessment of all risks together with relationships with each other. iv. Training Level of supply can be sustained by facilitating start-up conditions via provision of information, effective regulations, and training. It should also be the primary role of governments and business community to formulate effective market structures. The market structures need to include risk management tools, such as marketing contracts, insurance, and futures (Glauber, 2004: 1180). v. Focus on catastrophic risks Although they are rare, occurrence of catastrophic-risks leads to significant damage. Consequently, occurrence of such events reduce supply leading to high price levels. Governments and business community should be at the forefront in crafting contingency plans to define responsibilities, procedures and limits of policy response. References Arias, B., & Harri, A. (2000). Optimal hedging under non-linear borrowing cost, progressive tax rates, and liquidity constraints. The Journal of Futures Markets, 20 (4). John Wiley & Sons, Inc., New York. Chambers, R.G. and J. Quiggin (2003), ―Price Stabilization and the Risk Averse Firm, American Journal of Agricultural Economics, 85(2): 336-347 ECLAC (2008). International price volatility and economic policy challenges in Latin America and the Caribbean. Santiago, Chile, ECLAC. Glauber, J.W. (2004), ―Crop Insurance reconsidered, American Journal of Agricultural Economics, 86, 1179-1195. Part B Both traditional and the new trade theory are instrumental in explaining the differences existing between inter-industry and intra-industry trade. Although the words ‘inter-industry’ and ‘intra-industry’ appear very similar, they differ greatly in meanings. To begin with, the term inter-industry trade connotes trade in products from various industries. For example, inter-industry trade occurs when an agricultural product is produced in one nation using technological equipment imported from another nation (Dudovskiy, 2012: 1). Countries commonly engage in inter-industry trade based on their comparative advantages. Conversely, intra-industry trade is an undertaking concerning products belonging to the same industry. Ideally, intra-industry trade is a business undertaking involving similar products. Intra-industry trade has been a leading factor in trade growth over the past decades. The type of trade is associated with fragmentation of production, which is common in current business environment because of adoption of new technologies and globalization (Dudovskiy, 2012: 1). Terminologies like offshoring and outsourcing can describe instances of intra-industry trade. Traditional trade theories based explanation of international trade patterns on unlimited free trade and comparative advantage. Proponents of traditional trade theory maintained that each country had comparative advantage over others because certain products could be produced at comparatively lower cost (Sunanda, 2010: 1017). The theory suggested that comparative advantage emanated from inherent factors, such as climate and natural resources. The theory indicated that every country must seek to specialize in areas where they achieved comparative advantage. The new trade theory, which became popular during the 1960s and 70s, was formulated based on realization that economies producing similar products continued to participate in trade with each other. Such trading activities took place despite having nothing to gain based on criteria established under the international trade theories. The new trade theory emerged to substantiate existence of trade between economies with similar circumstantial landscapes. According to new trade theory, comparative advantage did not just emanate from variation in resource availability, but rather economies of scale (Davis, 1995: 201). The new trade theory noted that the most fundamental determinants of international trade patterns were economies of scale and network effects existing in key industries. Need for variety of goods at national level becomes an incentive for engaging in trade with other nations, even under situations where there are no known advantages. For a long time, the traditional theories of comparative advantage, created based on assumptions of perfect competition and constant return to scale, were thought to be incapable of explaining intra-industry trade. On the contrary, the new trade theories, based on economies of scale, provide a simple account for intra-industry trade. According to the new trade theory, existence of economies of scale provides motivation for specialization within an industry (Sunanda, 2010: 1029). Such instances have been witnessed in aviation industry and motor vehicle industries. In those industries, countries have specialized in production of various parts, which are then assembled to form a car or airplane. From the traditional theory of trade, comparative advantage can also be used to explain intra-industry trade. Technical differences existing in one part of an industry can act as a platform for operation of comparative advantage. Such an instance can be understood by consideration of the Ricardian trade pattern, which indicates that sectoral-technical differences influence trade patterns, especially when an individual sector cannot considerably increase marginal costs (Davis, 1995: 202). Regarding inter-industry trade, traditional trade theories can be easily used to give a clear account. Inter-industry trade takes place between nations because of existence of comparative advantage. Comparative advantage exists because one nation can specialize in one industry where it can produce goods or services at lower costs due to availability of raw materials or favorable climatic conditions. Inter-industry trade can thrive under conditions specified in the traditional trade theory (Sunanda, 2010: 1012). The theory championed for use of free trade to encourage nations to specialize in what they could produce at lower costs and then exchange for goods and services from other countries. The new trade theory has also been used to explain inter-industry trade. Notably, the theory is based on economies of scale and use of government regulations to protect home industries. A nation having no comparative advantage in producing a certain product can still participate in trade via importation of raw materials from other nations to facilitate mass production. In the past, instances of inter-industry trade have been witnessed, such as trade in agricultural goods from one nation produced with aid of a technological product from another nation (Davis, 1995: 218). The new trade theory can also be seen in outsourcing of personnel from one industry to another to facilitate efficiency in production. When professionals are moved from one industry to another, skills are transferred to facilitate mass production. In conclusion, intra-industry trade and inter-industry trade are realities that have been witnessed in the business world. Both traditional trade theories and new trade theories have been instrumental in comprehending the concept. However, in some instances, assumptions that used to underlie the scope of the theories have been eliminated, owing to dynamic nature of business world. For instance, Ricardian model was used to proof that new trade theory included an element of comparative advantage, whose proponents had initially rejected. References Davis, D. (1995). Intra-industry trade: A Heckscher-Ohlin-Ricardo approach. Journal of International Economics, (1995) 201-226. Dudovskiy, J. (2012). Inter-industry and intra-industry trade. Heckscher-Ohlin model. Retrieved from: http://research-methodology.net/inter-industry-intra-industry-trade-heckscher-ohlin-model/ Sunanda, S. (2010). International trade theory and policy. Development and Change, 36 (6): 1011-29. Read More