BUSINESS ECONOMICS - III

INTRODUCTION
In the 1600 and 1700 centuries, mercantilism stressed that countries should simultaneously encourage exports and discourage imports. Although mercantilism is an old theory it echoes in modern politics and trade policies of many countries. The neoclassical economist Adam Smith, who developed the theory of absolute advantage, was the first to explain why unrestricted free trade is beneficial to a country. Smith argued that 'the invisible hand' of the market mechanism, rather than government policy, should determine what a country imports and what it exports. Two theories have been developed from Adam Smith's absolute advantage theory. The first is the English neoclassical economist David Ricardo's comparative advantage. Two Swedish economists, Eli Hecksher and Bertil Ohlin, develop the second theory. The Heckscher-Ohlin theory is preferred on theoretical grounds, but in real-world international trade pattern it turned out not to be easily transferred, referred to as the Leontief paradox. Another theory trying to explain the failure of the Hecksher-Ohlin theory of international trade was the international product life cycle IPLC theory developed by Raymond Vernon.

International Product Life Cycle Theory (IPLC)

The International product life cycle theory is a valuable instrument in analysing the effects of product evolution on the global scale. The IPLC generally applies to established companies in industrialised countries who expand their product range. The theory is broken up into five major areas;

Release: As competition in Industrialised countries tends to be fierce, Manufactures are therefore forced to search constantly for better ways to satisfy their customer needs. (Ball et al, 1999). The core elements in new product design are gained from customer feedback from previous models. Once the product enters the domestic market and begins to create a positive reputation, the demand increases and hence we come to an end of the first stage of the IPLC.

Exports: As the product receives positive customer response, the international demand for the product begins. The manufacturer begins exporting to increase its market share. An example of this was the personal computer (PC) craze of the early 80s. In 1985 55,000 PCs were sold in the United States, by 1984 the industry had experienced a 136-fold increase to 7 million PCs (Richter-Buttery, 1998)

Foreign Production begins: As demand increases with the new global market, it becomes economically feasible to begin local production in various nations. By sharing technology on the manufacturing of the product, the company has lost an advantage. The end of this stage signifies the highest point in the International Product Life Cycle Theory.

Foreign Competition in exports markets: This is a threatening stage for the company. Local manufactures have gained experience in producing and selling their product, hence their costs have fallen. As they have saturated their initial market, they may begin to look elsewhere (i.e. other nations) to promote their product. The reason that this is threatening for our company is that this other nation may have a competitive advantage and this places stress on our market share.

Import Competition in Home Market: If the competitors have a competitive advantage, or they reach the economies of scale needed, they will enter the original home market. At this stage the competitors will have a quality product which will be able to undersell the original manufactures. Eventually they will be pushed out from the market and imports will supply the home nation. Eventually, as the products technology becomes more renowned, developing nations will enter the market. This will begin the International Product Life Cycle again, as these nations have a competitive edge with their low labour costs. With future innovations and new products and services the eventuality is that its value and hence its price are likely to diminishs.

The IPLC theory does have its disadvantages. Perhaps the most recognisable is the assumption that products are released initially in the domestic markets. Many globalised companies tend to release their new product lines internationally, not domestically; hence this theory can not be applied to many of todays products.

IMPACT OF GATS ON THE INDIAN ECONOMY The General Agreement on Trade in Services came into existence as a result of the Uruguay Round of negotiations and entered into force on 1st January 1995 with the establishment of WTO. The aim of GATS is to gradually remove all barriers of trade in services. The agreement covers services as diverse as banking, education, healthcare, tourism or transport. India also signed all the agreements under the single undertaking rule and GATS is a part of this whole package Basic purpose of commitment is to strengthen our economic position and global competitiveness, but not at the cost of national security, public health and safety, and environment protection. India prefers national level policies that take into account external factors, rather than pooled mechanisms at the international level. Gradual approach: India believes in gradual and step-by-step approach and not a Big Bang or Shock Therapy approach. Human face: All our reform programs have strong emphasis on human face and least sacrifice made by the people. Sovereignty constraint: Indian government tries to minimize the loss of power for national policy formulation that could result from international cooperation. Political constraint: India is a sovereign democratic republic with independent judiciary, and all external relations are based on general political consensus. Agency constraint: Policies are influenced by the ideology of the political parties in power. But once adopted, policies are irreversible. Preference for decentralization: India prefers national level policies that take into account external factors, rather than pooled mechanisms at the international level. Priority reforms: Basic purpose of commitment is to strengthen our economic position and global competitiveness, but not at the cost of national security, public health and safety, and environment protection.

India signed the Fourth Protocols in 1997 for telecom services. In general, India's current policy is more liberal than its scheduled bindings. For example, for voice and mobile telephone services, commercial presence may be established through incorporation in India and a license from the designated authority. Total foreign equity in the company is scheduled not to exceed 25%, although the current policy allows foreign equity up to 49% for these services. India also declared that it would examine the issue of allowing competition from the private sector in international long-distance telecommunication services in 2004; this date was brought forward to 2002. In financial services, initial negotiations continued till 28-07-1995 when an interim agreement up to 31-12-1997 was arrived at. India made the following commitments.

(a) Banking (i) (ii) (iii) Only a branch presence 5 licenses per year. Entry to new foreign banks may be denied if market share of assets of foreign banks exceeds 15% of total assets of banking system.

(b) Non-Banking Financial Services (i) (ii) Items allowed included Merchant banking, Factoring, Financial leasing, Venture capital and financial consultancy. Government allowed local incorporation with a maximum equity of 51 per cent by foreign financial services suppliers including banks.

(c) Insurance India made no commitment in life insurance area. In non-life insurance, India committed to continue with the current practice, which was quite restrictive

(d) Reinsurance, Retrocession & Insurance intermediation relating to reinsurance. A minimum of 10% of the premium of overall was committed to be reinsured abroad.

INDIAS ENHANCED OFFER During negotiations in June-July 1995, India made an enhanced offer, which included a liberalized policy on ATMs i.e. an ATM will not be treated as a separate branch, an increase in the number of new bank branches to 8 and inclusion of Stock Broking in the schedule with maximum foreign equity of 49%. This offer was made to obtain improvement from Indias major trading partners in the movement of natural persons. Consequently, the EU, Norway, Switzerland and Australia tabled an offer on movement of natural persons for the first time and did not insist on the economic needs test. Under the Fifth Protocol signed in 1998, India made the following commitments: (i) (ii) (iii) (iv) (v) (vi) (vii) MFN exemptions relating to banking services were withdrawn subject to other WTO members undertaking MFN-based commitments. Number of bank branches to be opened per year for both existing and new foreign banks increased from 8 to 12 per year. Banks were allowed to install automatic teller machines (ATMs) at branches and at other places identified by them. In insurance, status quo is maintained. In the area of reinsurance, the existing binding was aligned to the market. Both national treatment and market access are unbound for NBFCs. New commitments in stock broking and financial consultancy services.

At present, in actual practice, new bank branches for foreign banks being allowed by the RBI are 15 per year though our commitment is only for 12 branches per year. The guidelines issued by RBI so far go also beyond the commitments made in NBFC sector

MANAGED FLEXIBILITY An exchange rate control policy in which an exchange rate that is generally allowed to adjust to equilibrium levels through to the interaction of supply and demand in the foreign exchange market, but with occasional intervention by government. Also termed managed float or dirty float, most nations of the world currently use a managed flexible exchange rate policy. With this alternative an exchange rate is free to rise and fall, but it is subject to government control if it moves too high or too low. With managed float, the government steps into the foreign exchange market and buys or sells whatever currency is necessary keep the exchange rate within desired limits. This is one of three basic exchange rate policies used by domestic governments. The other two policies are flexible exchange rate and fixed exchange rate.

The policy players are Central Bank The primary players in most managed exchange rate policies are one or both of the governments issuing the currency being exchanged. The specific policy decision makers are usually the central banks of the countries. A central bank might operate independently or in cooperation with the central bank of another nation. For example, the Federal Reserve System keeps a close eye on exchange rates between the U.S. dollar and the currencies of other nations, taking actions when deemed necessary. However, it often works with the Bank of England, the Bank of Japan, and other central banks to keep the dollar-pound, dollar-yen, and other exchange rates under control. International Agencies Other major players managing exchange rates are international agencies, especially the International Monetary Fund (IMF). The IMF is an agency chartered by the United Nations specifically charged with monitoring and stabilizing foreign exchange rates. It has stockpiles of the currencies of member nations (over 150) that it uses when needed to manage exchange rates. Should the Mexican peso fall abruptly relative to the Brazilian real, then the IMF might step into the fray and buy a few Mexican pesos and sell a few Brazilian reals.

How it Works Foreign exchange markets are essentially "over-the-counter" markets, with buyers and sellers located around the globe. Central banks and the International Monetary Fund regularly monitor the exchange rates negotiated among the currency buyers and sellers. With a managed float, the foreign exchange markets carry on normal day-to-day activity as exports, imports, investors, and speculators buy and sell the currencies needed to conduct their business activities. If, however, an exchange rate looks to be rising or falling too much, moving outside the range that the policy players deem acceptable, then they are likely to step into the fray, doing whatever buying and selling of currency is necessary to keep the exchange within bounds. Suppose, for example, that the United States, Britain, and the International Monetary Fund have decided that an exchange rate between 1.9 and 2.1 U.S. dollars per British pound is suitable for maintaining a stable global economy.

Too High: If the exchange rate rises to say 2.2 dollars per pound, outside the targeted range, then one or more of the policy makers is inclined to take action. In this case, the British central bank, Bank of England, might sell a few British pounds and buy a few U.S. dollars. By adding pounds and taking away dollars, the exchange rate of dollars per pounds decreases.
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Too Low: Alternatively, if the exchange rate falls to something like 1.8 dollars per pound, then reverse action is in order. In this case, the U.S. central bank, the Federal Reserve, might sell a few U.S. dollars and buy a few British pounds. By adding dollars and taking away pounds, the exchange rate of dollars per pounds increases.

BALANCE OF PAYMENTS OF INDIA IN THE POST REFORM PERIOD Indias balance of payment worsened in the year 1990s but now the situation is under control. In fact, India has a good foreign exchange reserves manily due to capital inflows from foregin financial instituitions or the stock exchange. MAIN COMPONENTS OF INDIAS BALANCE OF PAYMENTS Trade Balance Trade Balance was in deficit through out the period as imports always exceeded the exports. Within the imports The POL items constituting a sizeable position continued to increase throughout. Exports did not achieve the required growth rate. Trade deficit in 2005 06 stood at $ - 51,841 billion US $. Current Account Current Account balance includes visible items and invisibles is in a more encouraging position. It declined to $ - 2,666 million in 2000-01 from $ - 9680 million in the 1990-91 and recorded a surplus in 2003-04 to the extent of 14,083 million. In 2005-06 , once again there was a deficit for & 9,186 million. The main reason for the improvement during 2001 05 was the success of invisible items. Invisible The impressive role palced by invisibles in covering trade deficit is due to sharp rise invisible receipts. The main contributing factor to rise in invisible receipts are non factor receipts and private transfers. As far as non factor services receipts are concerned the main development has been the rapid increase in the exports of software services. During this period the private transfer receipts also increase from $ 2,069 million in 1990 -91 to $ 24,102 million in 2005 06. The current trend of outsourcing number of jobs by developed countries to the developing ones is also helping us get more jobs and earn additional foreign exchange. Capital Account Capital account has been positive throughout the period. NRI deposits and foreign investments both portfolio and direct have helped to a great extent. The main reasons for huge increase in capital account is due to large capital inflows on account of FDI. FIIs investment on the stock markets and also by way of Euro equities raised by indian firms. The Non resident deposit also form a part of capital account.
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Reserves Reserves have changed during this period depending ona balance between current and capital account. An increase in inflow under capital account has helped us to build up our foreign exchange reserve making the country quiet comfortable on this count. In April 2007 we have $ 203 billion foreign exchange reserves. The year 2005-06 registered the highest trade deficit so far running into $ 51,841 million , because of rising Oil prices, as a result despite impressive positive earnings as much as $ 42,655 million from invisibles, the current account deficit in this year was $ 9,189 million which is 1.1% of GDP. CONCLUSION The balance of payment situation started improving sinch 1992093. There was a satisfactory balance of payement position in that period, the reasons are High earning from invisibles Rise in external commercial borrowings Encouragement to foreign Direct Investments The positive earnings from invisibles covered a substantial part of trade deficit and current account deficit reduced significanctly. The external commercial borrowings was extensively used to finance the current account deficit. The net not resident deposits were positive through out the ten year period. There has been a growing strength in Indias balance of payment position in the post reform period inspite of growing trade deficit and current account deficit.

BIBLIOGRAPHY

WTO (2002), Trade Policy Review India, Geneva, June 2002. Levine, Ross (1997) Financial development and economic growth: views and addenda, Journal of Economic Literature, June 1997. Reserve Bank of India (2003), Report on Trends and Progress of Banking in India 2002-03, Reserve Bank of India, Mumbai, December 2002. Das, Tarun (2003b) An Assessment of Trade in Services- A Case Study for India, Indian Council for Research on International Economic Relations (ICRIER), New Delhi.