International Business and the Balance of Payment - Essay Example

International Business and the Balance of Payment Introduction The trend of globalization and internationalization of businesses has brought about global advancement in the worldwide economy uplifting the third world countries involved in international ventures of multinational firms. However, this development has its undesirable setbacks to the poorer countries in the international and foreign ventures. Mann (1977) asserts that there is now a growing realization that the institutional power of multinational corporations, particularly those American-based ones which dominate the world structure of capitalism brought about some negative impacts on third world countries. The outward movement of a firm's international operations is considered as internationalization, not only in terms of the number of markets served, but also in the operation methods utilized. Johanson and Vahlne (1990) define internationalization as "a process in which the enterprise gradually increases its international involvement. This process develops the relationship between the development of knowledge about foreign markets and operations on one hand and escalating commitment of resources to foreign markets on the other. Many critics view multinational corporations as a negative factor in the development efforts of Third World Countries; Hymer (1970); Hopkins (1969); Mullier (1973) found that the multinationals are perceived as a principal source of the underdevelopment of Third World Countries. Moreover, Frank (n.d.) supports this statement by saying that multinational corporations create net capital outflows, contribute to problems in balance of payment, distort the domestic consumption patterns, export unsuitable technology and products at excessive prices and, most emphatically, do not solve the unemployment problems. In addition they aggravate economic and social inequalities in the host countries through the formation or the intensification of a small group of indigenous elites who collaborate with and benefit from the multinationals. Balance of Payment Balance of payments is an important factor that greatly influences the internationalization process of many firms. A deficit in the balance of payments of a host country might force the government to use artificial barriers (i.e. tariffs and quotas) to limit and control imports. Managers can utilize the evaluation of the level of GNP in a host country in making important decisions not only by providing them with an indication of a potential consumer base in the market and average income per capita, but also by helping the managers to forecast the future trends in a foreign country's economy (Vernon and Wells, 1980). Currency and Balance of Payment Rigorous crises in balance of payments and currency take place with some occurrence in emerging-market economies--more than 51 crisis episodes over the past 25 years, demonstrating that about 8 percent of the time an emerging-market economy was facing serious turbulence in currency markets. Likewise, this frequency of currency crises appears to be a reoccurring phenomenon, persistent over time and across regions of the world (Glick and Hutchison, 2001). In terms of the other variables of the model, study of Glick & Hutchinson (2001) concluded that actual exchange rate overvaluation is a significant factor slowing output growth. This finding is discussed comprehensively in Moreno (1999). In view of the fact that real overvaluation also takes part in an essential role in generating currency and balance of payments crises in the first instance (Glick and Hutchison, 2001), the undesirable effects emerge to work through two channels – the direct and the indirect channel. The direct channel is to reduce real output by weakening in export competitiveness. The indirect channel is by contributing to a currency crisis, which in turn is associated with a disruption in financial markets and a downturn in output growth. A decline in growth in major trading partners, not surprisingly, is an additional factor contributing to a slowdown in emerging markets. A Case of Indonesia In the past decades, Indonesia experienced an increased pressure on foreign debt service on the country's balance of payment position. It has been the source of a bigger current account deficit. A table provided by the Indonesian Newsletter in 1992 shows the debt interest payments increased from US$ 1,132 million in 1982 to US$ 2,669 million in 1991. How did the imbalance of payment affect the economy of Indonesia? Debt installment payments represent a burden on the flow of capital to the country. Correspondingly, they are subtracted from the amount of foreign loans and investments to Indonesia, which are essentially expected to finance projects that can generate employment opportunities as well as increase national income and exports. In 2004, Indonesia’s balance of payment is expected to suffer a deficit of US$1.5 billion as a result of a rise in state debt repayments according to Deputy Bank Indonesia Governor Hartadi Sarwono (as cited in Xinhua News Agency 2003). This is also in line with the Indonesia putting an end to its IMF cooperation. As a result, the government must repay its offshore debts as well as principal and interest apparently causing the balance of payment to experience a deficit of US$1.5 billion. Nevertheless, Indonesian government counts on the capability of their foreign exchange reserves that is believed to sustain deficit in balance of payment. Balance of Payments in Developing Countries On the other hand, many firms in a developing country like the Poland still consider going international as an imperative means in reducing the country’s balance of payment deficit. In addition to that, firms in these countries have seen internationalization as a viable alternative as one of the fundamental contributors to the country’s economic growth (Klonowski 2005). The economic prosperity of Poland depends on the effectiveness of local firms in extending their operations in the international context. Furthermore, export activity has been identified as a critical driver of economic growth in many countries (Khalafall and Webb, 2001; Burgess et al., 1997; Tyler, 1981; Kavoussi, 1984). However, there are also particular cases of difficulties experienced by developing countries in their balance of payment. Balance of payments difficulties in some extent emerge to be a prevalent and widespread disease among developing countries. Last decade’s economic orthodoxy teaches that the developing country should first enact a package of "reforms" to cure the situation in the medium term in order to qualify for short-term international loans to tide over the present crisis (Johnson 1995). The fundamental features common to most of such packages are that the government agrees to devalue the currency and to tag along a program of fiscal and monetary control and restraint to deflate the economy. In the actual setting, the International Monetary Fund is usually the immediate party that must lengthen and extend the international loans and, therefore, decide if the package of reforms will meet the requirements. However, governments of both developing and developed countries are being forced to enact such programs and complain to the International Monetary Fund regarding the conditions. Their justification criticize it saying that they will cause a lot of problems like an increase in unemployment, lower the real national income, harm the distribution of income, and in most cases have not improved the balance of trade (as cited in Johnson 1995). All these protests and criticisms are unfortunately have not caused any changes in the IMF even though most of the countries’ complaints have been right and acceptable. Moreover, Johnson (1995) asserts that it should also be stated that it is not clear that the IMF, given the tools at its command and its legal charter, has had much power to respond in any way other than it has. This calls for is a reassessment and reevaluation of the tools and charter should constraints be eliminated. Tracing the Cause of the Problem Part of the problem, says Johnson (1995) lies in traditional/conventional economic theory, which concludes that the complaints of the developing countries' governments are unfounded. Traditional theory would say that the IMF package is the appropriate one to cure the deficits in balance of trade, in view of the fact that the devaluation will lead to improved profitability, and consequently follows an increased production, of export goods and import-competing goods. Production in these sectors will be stimulated and prompted, and devaluation by itself is hence necessarily expansionary. These expansionary effects would then be reckoned by the second half of the standard package set by the IMF: “the contractional fiscal and monetary policies”. Johnson (1995) makes a final point that the traditional theory does agree that real incomes may occasionally fall in the short term as a consequence, but this is due only to the nation "living beyond its means" previously. Conclusion Multinational corporations have been proven by the study of Mann (1977) to be the cause of retardation of all other aspects of development in addition to its contribution to the gross national product. The benefits they generate are enjoyed by the multinationals, by the investors, and by a small segment in the host country. The rest of the population remains in perpetual impoverishment. The local economy continues to be a satellite of the metropolis, and a parasitical relationship exists between the national bourgeoisie and the people. In short foreign investments are a continued source of underdevelopment in poorer countries. A variety of forms of response to foreign investment have emerged and have been mentioned in this paper. Some countries continue to welcome them with open arms. Others, while more careful, still believe that gradual economic reforms will control the multinationals and that the host country will benefit from the relationship. Still others have detached most relationships with foreign investors (e.g. Indonesia) while they have attempted to build a truly self-sufficient and independent society. References Burger, S. & Oldenbloom, N. (1997). South African and Singaporean exporters: their attitudes, information sources and export problems. South African Journal of Business Management. 28(2). Frank, A.G. (n.d.). "The Development of Underdevelopment" in C. Wilber, op. cit., pp. 94-104. Hutchinson, M.M. & Noy, I. (2002). Output Costs of Currency and Balance of Payments Crises in Emerging Markets. Comparative Economic Studies, p. 27+. Indonesian Commercial Newsletter (1992 August 10). Foreign Aid Continues, but be Careful: Foreign debt service also increases pressure on balance of payment position. Retrieved 05 May 2006. Indonesia's balance of payment to suffer deficit in 2004. Xinhua News Agency; 10/23/2003 Johnson, N. (1995). Balance of payment difficulties in developing countries. Carribean Today, March 03. Kavoussi, M. R. (1984). Export expansion and economic growth: further empirical evidence. Journal of Development Economies. 14, pp. 241-250. Khalafalla, K. Y. & Webb, A. J. (2001). Export-led growth and structural change: evidence from Malaysia. Applied Economies 33, pp. 1703-1715. Klonowski, D. (2005). Internationalization of Polish Firms: Developing a Typology of Local Exporters. East European Quarterly. 39(1), p. 83+. Mann, L. (1977). Some Effects of Foreign Investment: The Case of Malaysia. Bulletin of Concerned Asian Scholars. 9(4), p. 14. Moreno, Ramon (1999). "Depreciation and Recessions in East Asia," Federal Reserve Bank of San Francisco Economic Review, 3, 27-40. Stephen Hymer, (1970). "The Multinational Corporations and The Law of Uneven Development" in J. N. Bhagwati (ed.) Economic and World Order (New York: Oceana. Terence Hopkins, (1969 November). "Third World Modernization in Transnational Perspective" in The Annals of American Academy of Political and Social Science. pp. 126-137. Tyler, G. W. (1981). Growth and export expansion in developing countries: some empirical evidence. Journal of Development Economics. 9, pp. 121-130. Ronald Müllier, (1973). "The Multinational Corporations and the Underdevelopment of the Third World" in Charles Wilber (ed.), The Political Economy of Development and Underdevelopment, (New York: Random House). Read More