International Business

Week Three – Case Study:

China’s Managed Float

1- Why did China originally peg the US Dollar? What are the Pros? What are the cons?

In 1994 the US Dollar was the dominant world currency and for China a target export nation. Only 20 years earlier based on the Bretton Woods agreement all exchange rates were fixed on the US dollar. (Actually, they were fixed on gold, but the US dollar was the only currency that could be changed for gold.) Many of the small countries pegged their currency to the US Dollar once Bretton Woods broke down even though the breakdown was caused by US policy (Hill p.359). By stabilizing the exchange rate between the US and China, they were reducing the risk of foreign investment and economic exposure. This reduced risk gave the US and others who would be marketing to the US through China a stable means of converting money. It effectively reduces the risks associated with volatility of foreign direct investment.

When China pegged the US Dollar many advantages for the global economy as well as China itself were seen. First off, the global economy has seen advantages by eliminating competitive devaluations and forcing China to hold stringent economic policies to reduce inflation (Hill p.358). Additionally, China has benefited from very low inflation rates until recently and strict economic policies that have protected their monetary system. This protection from inflation and the trade surplus have actually made the Yuan undervalued. This gives them a significant advantage when exporting to the US or any other nation that allows their currency to float freely.

There are also some negative effects of the pegged Yuan. According to BloggingStocks.com as the dollar depreciates the costs of consumer goods in China rises, especially imported goods. This means inflation beyond the protection of the dollar. Now that the dollar is depreciating, so are any currencies that are pegged (or managed) to them.

2- If China floats the Yuan, what will happen to foreign enterprise doing business in China?

Firms doing business in China will have one significant problem to deal with. There was once a pegged dollar and the Chinese costs could be held constant according to their home (if they were US based) or the market. Now if the Yuan were to float freely, by some estimates, it could revalue at 40% higher despite a 20% change since 2005, which translates to a 40% increase in operation cost in China (Wikipedia). That estimate may be extreme but the cost for operations would increase significantly enough that the advantages of manufacturing in China will be severely reduced. Strategies would need to be re-evaluated and maybe China as a market may come as a new focus.

3- How would a floated Yuan effect future FDI?

In the short term, foreign direct investment would decrease because of the large amount of inflation that would happen rather rapidly. This would make the rational for manufacturing in China to be less reliant on low cost labor. Companies would take their money to a different global location where the future was more predictable until China was able to give substantial reasoning for continued investment.

Long term may have different outcome if the Yuan were allowed to freely float. The market would be changed more closely to a free market where efficiency was sought. This efficiency would force China to find their niche and focus on what they do best. When regions or nations are able to specialize in what they do well, they can put all their energy into doing that one thing better. These efficiency gains make them more desirable when evaluating where to invest.

4- What circumstances, if the Yuan were floated, would China destabilize? What are Implications?

In 2005 China allowed their currency to start slow revaluation, based on a “basket” of other currencies (Washington Post). Since that time it has risen about 20% and continues to rise against the dollar (Wikipedia). The change in valuation has more to do with the inflation of the dollar than China actually revaluing.

The destabilization of China could happen if the revaluation were to take place very rapidly. Nearly all economists agree that they need to revalue, but how quickly and to what extent is what is still in contention (NPR). If it were instantaneous all Chinese firms that have export capabilities would be hurting for profits and would ultimately loose business. This quick loss of business could cause a downward spiral of the entire economy if there was no intervention by the Chinese government. This means that the government should be slowly easing its way into the free float market so that market efficiency could be improved on the global scene.

5- Should the US push China to float the Yuan? Why?

The US should push China to revalue. We must use very cautious and diplomatic means to avoid putting our economy (or theirs) into a tailspin. We are currently in a precarious position economically, and I believe that now is not the time to press China into the revaluation process. The non-US dollar pegged currency is a good first step as well as allowing 0.5% change each day. These are the slow methodic means of transforming the global economy into an efficient one with competition, free trade and commonly valued monetary systems that are not controlled by governments.

6- What should the Chinese government do with currency value?

I believe that most governments are looking out for the best interest of the company in the long run (although looking at the US government and the current presidential race, I might disagree). China would be better off in the long run to slowly make steps to revalue its monetary instruments. These steps may include modifying the “basket” of currencies it is pegged to until they believe it is close enough to the free market cost. Once it is near free market value they can plan to change it to float freely. If they can stretch this over the next 5-10 years they will be able to make it through the process and not be solely known as a low labor cost country but be developing an efficient, specialized niche where they can be successful on a level playing field.

BlogginStocks.com. China learned that Yuan-dollar peg is a two-edged sword. Retrieved May 30, 2008 from: http://www.bloggingstocks.com/2008/01/07/china-learned-that-yuan-dollar-peg-is-a-two-edged-sword/

Hill, Charles (2008). International Business: competing in the global marketplace, e7. New York: McGraw-Hill Irwin.

NPR. Q &A: How China’s currency policy effects you. Retrieved May 31, 2008 form: http://www.npr.org/templates/story/story.php?storyId=5353313

Washington Post, China end fixed-rate currency. Retrieved May 30, 2008 from: http://www.washingtonpost.com/wp-dyn/content/article/2005/07/21/AR2005072100351_2.html

Wikipedia. Renminbi. Retrieved May 30, 2008 from: http://en.wikipedia.org/wiki/Renminbi

International Business

Week Two – Case Study:

Boeing Versus Airbus: Two Decades of trade Disputes

1- Could Airbus become a competitor without subsidies?

Unless there was some significant technology advantage that allowed Airbus to produce jet more efficiently, there is no way that they could have become a competitor so quickly. Hill states that:

“a significant experience curve exists in aircraft production. Due to learning effects, on average, unit cost fall 20 percent with each doubling of accumulated output….A company that achieves only half of the market share required to break even will suffer a 20 percent unit cost disadvantage.” (Hill p.310)

This means that any smaller company (in terms of production volume) is at a significant exponential disadvantage dependant on size. This fact alone would make it near impossible to advance as quickly as they had.

One benefit they had was their marketing strategy of serving markets that were not served by the two large aircraft manufacturing companies at the time (Boeing and McDonnell Douglas). Additionally they were a consortium of smaller manufactures that could see the benefit from working together to get efficiency gains from size and specialization. Given these strategy Airbus may have become a dominate player, but it would have taken much longer for them to reach the number one spot.

2- Why did the EU subsidize Airbus?

The four governments in the EU which agreed to subsidize the Airbus consortium chose to do so because it was a benefit to their local and regional economies. By endorsing the aircraft industry in Europe, they were enabling growth potential for manufacturing as well as the ability of the region to export products to other parts of the world. At the time the US housed the only large scales aircraft manufacturers and the EU wanted a piece of the pie. Additionally, they knew that by adding a serious competitor (Airbus) the state run airlines would increase global competition and drive the cost down and production efficiency up. It is a win-win situation for the region.

The political support was not enough to ensure that the company could last long term. Each member company and member nation knew the statistics and the disadvantages that Airbus was up against if it were to compete on a global scale. Subsidies were necessary to ensure the new organization success. One of the problems I believe these nations ran into was that the subsidies were not in check. When they became a larger more successful global competition, there was no internal mechanism (aside from its competition and now the WTO) to remove some or all of the subsidies.

3- Does Airbus have a reasonable position about subsidies?

The mantra that Airbus took up was twofold. First, it was not their subsidies that made them successful but their superior strategy and technology (Hill p.311). As argued previously their strategy was good for a market player who was coming from behind, but with the early disadvantages they needed the additional support if they were to enter the market at a competitive level. If being competitive with Boeing was their goal they absolutely needed subsidies early on, but they are on a level playing field now.

Second the subsidies Airbus received were just making up for indirect subsidies and government aid US aircraft manufactures had received since 1970 (Hill p.310). They argue that the US subsidies continue today mostly in the form of tax breaks (Fox News). An article in BusinessWeek argues that the subsidies that Airbus continues to receive in R&D expenditures are against GATT Article 2 and Article 3 of the Agreement on Subsidies & Countervailing Measures.

4- Was the ’92 agreement reasonable?

The pact between Airbus, McDonnell Douglas and Boeing in 1992 must have been reasonable. I say that because all three companies agreed to it. That would be a huge undertaking in itself. The cost of arbitration and continued argument between the (now) two companies must cost millions of dollars each year. It was in their best interest to come to an agreement that was acceptable by all. It placed limitations of no or low cost loans and other forms of aid each company could get from their respective governments. These limits, by some standards, were not successful. BusinessWeek states that he “aircraft subsidies dispute [since 1992] is not whether Boeing or Airbus receives illegal government subsidies, [because] they both do.”

5- Why was industry cautious in ’93 when politicians tried to reopen debate?

When the debate was pushed to reopen in 1993 on the political front the industry was not interested in a battle. Hill presents the case that the renewed debate may cause retaliation against US suppliers of Airbus, which may result in lost US aerospace jobs (Hill p.312). I would suggest that Boeing in particular was just finishing the 777 project (New York Times) and was preparing for the start of the 787 Dreamliner. Since, according to BusinessWeek, both companies receive “illegal” subsidies, the debate would have been hypocritical.

6- With global competition, why do authorities allow large M&A?

With the increased global completion it is of benefit for nations to allow larger firms to become more competitive through mergers and acquisitions. As markets grow from reduced trade barriers, the larger firms have a distinct advantage because they are able to utilize the economies of scale for all aspects of their operations. If firms were not allowed to grow nationally using mergers or acquisition, other international firms would grow and soon domestic firms would be at a cost disadvantage. This process is part of the opening of the global markets. This same trend has been seen on a smaller scale in the US. Grocery stores are a good example of expanding markets. 100 years ago each town would have many locally owned shops. Soon, people began franchise or just open more shops nearby. Now the grocery market is dominated by regional chains of stores which is increasingly turning to national and I would predict internationally recognized names.

7- Was the threat to stop the merger a violation of US national sovereignty?

Was national sovereignty at stake when the EU threatened to stop the Boeing- McDonnell Douglas merger? I would have to say no. The market affected by such a change was international. In fact because the market is international it was in the best interest of the US government and antitrust authorities to encourage the acquisition. It was a benefit to the US to have the single largest aircraft manufacturer because it would reduce the national work being done by each company and enable them to be as efficient as possible by combining skills and knowledge as well as suppliers. Because there was such an advantage to the US there needed to be a market wide (global) organization that would be able to make the determination.

8- Was the EU right in requiring concessions? Should Boeing have conceded? What could have happened if not for the concessions?

The EU did not have the right to force the concession of the 20 year contracts with some suppliers, but it had the power to do so. Boeing was in a delicate situation because it was strategically the best move for them and the US but there were trade penalties that may be enforced if they did not cooperate with the wishes of EU Commission (Hill p.313). The case they had was not very strong. The first is a classic anti-monopoly move; if you merge there will not be enough competitors and prices will soar. The problem with this argument is that “Douglas accounted for less than 10 percent of production in the large commercial jet aircraft market and only 3 percent of new orders placed that year” (Hill p.312). Their next argument was that the technology used in military applications would find its way to passenger jets and thereby giving additional subsidies to Boeing. Again, this point is weak because Airbus was also receiving similar subsidies. The last one was something that could be negotiated, allowing customers out of 20 year contracts, which Boeing agreed to. Making this concession allowed the merger to continue but also showing that they were willing to work with the competition to become a law abiding global citizen.

9- Why did the US reopen the debate in ’04? Did the US have a good position? Did the EU have a good counter position?

The US reopened the debate about illegal subsidies because Airbus was in the process of overtaking Boeing as the world’s largest supplier of aircraft (BBC). This debate was identical to the previous decades of debate with neither side willing to stop taking subsidies or stop pointing fingers. Ultimately it was turned over to the WTO.

10- What would be a fair and equitable outcome from the WTO?

A Fair and equitable solution to the debate that is nearly 40 years old would be to identify all of the subsidies and any under the table subsidies and set allowable limits as to what is allowed and when. The most important part about this decision is how it will affect other nations that are also subsidizing their aircraft manufactures (BusinessWeek). This would include our neighbors to the north, Canada, Japan and China.

BBC. Airbus poised to overtake Boeing. Retrieved May 24, 2008 from: http://news.bbc.co.uk/2/hi/business/2656205.stm

BusinessWeek. Airbus subsidies don’t fly. Retrieved May 24, 2008 from: http://www.businessweek.com/debateroom/archives/2007/10/airbus_subsidie.html

Fox News. McCain denies lobbyists on campaign influenced inquiries into air force contract. Retrieved May 23, 2008 from: http://elections.foxnews.com/2008/03/11/mccain-campaign-advisers-lobbied-on-behalf-of-boeing-rival-in-air-force-tanker-deal/

Hill, Charles (2008). International Business: competing in the global marketplace, e7. New York: McGraw-Hill Irwin.

New York Times. Boeing 777 first flight. Retrieved May 24, 2008 from: http://query.nytimes.com/gst/fullpage.html?res=9C0DE0DE1E3AF930A25755C0A962958260