International Business Policy: China as an Investment Destination - Essay Example

INTERNATIONAL BUSINESS POLICY A REPORT ON CHINA AS AN INVESTMENT DESTINATION Table of Contents Page Executive Summary 3 2 Introduction 4 3 Globalizations of Trade and Investment 6 4 International Trade Theories 7 5 Political Economy of International Trade 10 6 Social Cultural Factors 11 7 Conclusion 12 8 Bibliography 13 1 Executive Summary The House of Pearl Fashions Ltd., (HPF) of India is looking at an opportunity of either investing or trading with China to take advantage of current expansion of International Trade in the liberalized era. The possibilities have been examined under various heads that are the ingredients of International Trade. Ever since the Chinese came out of their Walled existence and opened themselves to the International communities, they have become the focus of the whole world. Having the largest population on Earth opened up a marketing opportunity that was beyond comprehension to most conglomerates. Added to that the purchasing power dazzled one and all and Multinationals of all hues went headlong to get a piece of the action. It has been ascertained that both India and China are quite similar and are perusing similar liberalization policies. Culturally too there is affinity and therefore investing in China will be a wise move. . 2 Introduction Company Background As a growing garment exporter to the world with an annul turnover of over Rs 5000 crores, equivalent to $ 1.25 billion the House of Pearl Fashions Ltd (HPF) are faced with a dilemma of competition from China. With the onset of a quota free regime US and European countries are free to buy their requirements from any country of the world and China as a source of cheap labour as well as due to its effective control on the Yuan has emerged as a strong contender against export of Indian garments. HPF is actively considering converting this threat into an opportunity. They already have a trading presence in China through a wholly owned subsidiary Northwest Trading, the next logical step should be to set up a manufacturing unit in one of their special economic zones and make it another exporting hub taking advantage of their labour and currency factors. (House of Pearl). As their consultants we present this report on the conditions in China, with comparisons of our home conditions in India on various issues and make suitable recommendations to the CEO of HPF. Monetary Environment Prior to reforms the Chinese maintained an overvalued currency but with expansion in foreign trade IMF estimates that the Chinese currency lost about 70 percent of its value against the dollar in real terms over the period from 1980 and 1995, substantially enhancing the international competitiveness of China-based export operations. (International Monetary Fund 1996, 50a) China has a free currency system and conversions are allowed freely. But the currency of the land the Yuan is frozen against foreign currencies of the world. As against this there is no free conversion of currencies in India but the Indian Rupee is kept on a floating basis viz-a-viz foreign currencies and this is the reason of our competitiveness being challenged by China. Our export realizations are becoming less with the strengthening Rupee and dwindling dollar. Following a modest appreciation, the Chinese government effectively fixed the exchange rate at RMB 8.3 to the dollar in 1995, which was not changed until 2005. Economic Structure China is no longer a closed economy. Its entry into WTO has ensured that its tariffs are reducing to acceptable standards although for protection of its own industries like automobiles some tariffs are still high. But this is true of even the developed countries so it is not a stigma. By 2005, China’s average statutory tariff on industrial products will be 8.9 percent, by far better than most other emergent economies of the world. For Argentina, Brazil, India, and Indonesia, their respective percent figures are 30.9, 27.0, 32.4, and 36.9. China’s reforms are making it the most open large economy in the world today. China has committed to not raise any existing tariffs on industrial products above existing levels as some are reduced. India, in contrast, has committed only two-thirds of its tariffs in similar manner. (Hufbauer, Gary. and Rosen, Daniel 2000) Foreign Direct Investments (FDI) FDI is sought after for the benefits that accrue to the host country by way of resource transfers that brings in this scarce resource for the benefit of the industry, consumers, and the labour force. FDI is the cause of increase in capital, upgrading technology and improvement in management. It created direct employment by augmenting manufacturing capacities and indirect employment by assisting growth of ancillary industries and additional suppliers for new raw materials. Finally it improves the balance of payment of the host country and brings in more foreign currency to meet import and payment obligations. Competition China has the best FDI policies in the world and therefore attracts the most FDI despite its legal set-up. Its increased openness to foreign trade has led to a great degree of international competition that has the market forces deciding in favour of the Chinese products. Although its banking system is far from perfect yet there is a disciplined production and inefficiencies are being removed. Foreign producers are allowed to operate freely in China and this competitive pressure has intensified thereby raising the marginal productivity of both labour and capital. This augurs very well for our proposed venture. 3 Globalizations of Trade and Investment Globalization of Markets From the Prime Minister down it is the belief of all officials that the only alternative for domestic growth is through increase in foreign trade. Globalization is therefore officially welcome and involvement is patronized. Globalization of Production China has already become a global hub of apparel production. Major apparel importers of USA and Europe are already consolidating their positions by tying up with exporters from China in a big way. China has high productivity, low labour costs, and excellent infrastructure to ensure its stake in the world markets and there is likely to be a dramatic increase in its share of the Global apparel export market. Wal-Mart, which sourced 8 percent of its global purchases from China in 2002, and bought an estimated $15 billion of Chinese merchandise in 2003, have a clear incentive in minimizing the dollar-denominated production costs of their goods. (Zhao and Xing 2003a,b) 4 International Trade Theories There are several theories on International Trade. Mercantilism is a 16th century theory that symbolizes gold as wealth and propagates that exports should be subsidized to meet competition and imports should be penalized with tariffs to protect home industry. This severely limits the benefits and is a zero sum game. (Miller. David., et al 1987) The Absolute advantage theory was originated by Adam Smith, the father of modern Economics, and he proposed that one should produce in a place where one can be most efficient and should trade where production is marked by inefficiency. By and large this theory is in practice today. (Smith. Adam, 1776) The Comparative Advantage theory states that production should be decided on basis of relative advantage and if advantage is unavailable one should import rather than produce even if efficiency is more than that of the exporting nation. (Ricardo. David 1817) In contrast Heckcher (1919) and Ohlin (1933) theorized that one should produce and export goods from locally abundant factors of inputs and import those goods for which these factors are costly locally. Wassily Leontief (1953) developed his Paradox theory that states that Government policies affect availability of input factors as well as capital and labour. This is too totalitarian in approach. The Country Similarity theory advocated by Linder in the 1961 extended the previous theories by adding that nations with similar demand pattern trade with each other. The Product Life Cycle theory by Raymond Vernon in 1960 concluded that there are four stages of lifecycle of a product and international trade is related to them. In the first innovation stage the product is developed in its home country; in the second when it reaches its growth level it is produced in another developed country; when it is in maturity it is produced in a developing country and in the last stage where it reaches the declining stage of its life it may be produced just anywhere. This is how international trade in a product takes place. Paul Krugman and Kevin Lancaster (1980) projected that in their Market Imperfection theory the nation gains from its vantage point of specialization and economies of scale and having the first mover advantage takes centre stage with the assistance of the government. Here the use and need of the government factor is the limiting factor. Michael Porter (1990) put forward the Diamond Theory in which he stated that Basic Factors like natural resources, climate/location, and demographics when added to Advanced Factors like communications, skilled labour and technologies result in efficient production. This product is in high demand by sophisticated consumers looking for quality and innovations and firms cater to them and each feeds on the other to create International trade. There are other factors in the Diamond like related support industries, strategies in marketing, international, and domestic competition that either hinder or help in promotion of trade. These factors contribute to a company’s competitiveness. The diamond needs re-enforcement by adding two layers of International Trade and Global Trade with further factors built in. But this is a good base to start from. A SWOT is an analysis of an organization’s Strengths and Weaknesses (internal factors) and Opportunities and Threats (external factors). (McCarthy, E.J.1964), Our own SWOT analysis for setting up a manufacturing unit in China is given below. STRENGTHS 1 HPF is already in Garment Manufacturing, commencing in China will be an extension of same activity 2 The quality is acceptable in the International Markets 3 Chinese Government supports FIE 4 China offers cheaper labour at lower cost 5 Productivity of Chinese workers is high 6 Cultural affinity will aid in management 7 Fixed parity with Dollar will offer price stability and profitability 8 Tax exemptions for FIE will increase profitability and ROI WEAKNESSES 1 Legal Issues may cause problems as commercial law is weak in China 2 Difficult to get local managerial staff 3 Language Problems OPPORTUNITIES 1 HPF can attract more buyers from a Chinese base due to cost/price benefit 2 HPF can hire/fire workers more easily 3 With enhance and faster liberalization business can be expanded manifold 4 Better sourcing of raw materials on worldwide basis THREATS 1 Greater competition from Domestic Chinese Companies as they are supported by National Government 2 Protectionist policies of Government 3 Change in Government policy can affect operations 4 Any financial crisis in Chinese market can change profitability due to economic upheaval 5 If Yuan is devalued it will hurt bottom line It is apparent from the SWOT, which also considers Porters’ Diamond factors that the weaknesses are few and are possible to overcome with better management practices. Initially we can take senior managers from India who will train local managerial staff and over a period of time we can develop local talent for our needs. The greatest threat is the devaluation of the Yuan which is imminent. But if we take into consideration that the Chinese Government is not succumbing to International pressure and is devaluing at its own pace to protect its own garment industry, we can factorize this in our costs over a longer period of time. Overall the Strengths and Opportunities are far more attractive to loose this opportunity of setting up our next unit in China. 5 Political Economy of Foreign Direct Investment FDI, much of it export-related, has contributed to capital formation in China, but initially that contribution was relatively modest. In fact it declined from a peak of 17 percent in 1994 to about 7 percent in 2003. In the last decade the expansion has been phenomenal. It has crossed $ 400 billion in 2006. Expanding trade and FDI have contributed to Chinese living standards since the reform period began and particularly in the last decade. Chinese consumers have benefited from price declines and an increase in the quality and variety of goods consumed, and China has been able to revise its pattern of industrial production for comparative advantage. Moreover, these gains are shared with China’s trading partners, who have also benefited from cheaper imports, export sales to China, and returns from investment in Chinese companies. Financial Crisis The transition of China from a socialist system to market economy is truly remarkable. But it is in jeopardy because of a looming banking crisis that is due to a huge amount of non-performing assets of nearly USD 500 billion. They are mostly loans to State Owned Units (SOE) who are still the major employers of the working population. These threats become more real in view of the fact that China has a fixed rate vis-à-vis the dollar. This creates pressure on its trading partners as well as on competition. But it must also be noted that China is actively revaluating is currency, although at a slower pace than desired by the US. Under WTO agreements China is also committed to opening its financial markets and by and large it is keeping its promises and there is reason to believe that its leadership believes that it is in its interest to do so. But the slow pace should be judged in the light of what USA and other protectionist regimes are doing in their own backyards and seen in this light no blame can be put on China. 6 Social Cultural Factors International Trade is also affected by cultural factors. The culture and its consequences on individuals and companies determine the outlook on business ethics. This in turn effects decisions and policies. The six important elements of culture are Religion, Education, Economic Philosophy, Language, Stratification, and Political Philosophy. Determination of Culture The level of education, the depth of belief, the impact of economic and political thinking, and the distribution of wealth are sub-factors that determine culture. There are two contrasts in western and eastern culture. Whereas the west believes in the individual, the east believes in the group. In the west status means wealth while in the east power is status symbol. In case of China it is more like India in cultural values and migration to China for business will be an easier transition. 7 Conclusions From the above detailed analysis it is apparent that if HPF plans a venture into the Chinese market by setting up a Garment manufacturing unit it will be a good economic move. It will bring in cost advantages as well as higher productivity. Their existing trading arm will be of great assistance for initiating this undertaking. 7 Bibliography Heckscher, E. 1919. The effect of foreign trade on the distribution of income. Ekonomisk Tidskriff, 497–512. Translated as chapter 13 in American Economic Association, Hufbauer, Gary., and Rosen, Daniel. “American Access to China’s Market: The Congressional Vote on PNTR,” International Economic Policy Briefs, 00-3, www.iie.com, May 1, 2000. Lancaster, Kelvin. “Intra-Industry Trade Under Perfect Monopolistic Competition.” Journal of International Economics, 1980 10(2): 151-175. Leontief, W. et al. (1953), Studies in the Structure of the American Economy, White Plains, NY: International Arts and Sciences Press. McCarthy, E.J. (1964), Basic Marketing, Richard D. Irwin Homewood, IL. Miller. David., et al eds, The Blackwell Encyclopaedia of Political Thought (Oxford, 1987) Ohlin, B. 1933. Interregional and International Trade. Cambridge, Mass.: Harvard University Press, 1966. Porter, Michael.  1990.  The Competitive Advantage of Nations.  New York:  Basic Books.  Ricardo. David., The principles of political economy and taxation 1817 Smith. Adam., The Wealth of Nations, London 1776 Zhao, L. and Y. Xing, 2003, “Reverse Imports, Foreign Direct Investment, and Exchange Rates,” Hokkaido University working paper. World Wide Web House of Pearl available at: http://www.houseofpearl.com/ accessed on 13 Dec 2007 Read More