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Confronting foreign competition by overcoming trade barriers.

In a global economy, American firms are learning how to circumvent trade and investment roadblocks of nations seeking to protect their industries.

For a variety of political reasons - mainly to "protect" home industry owners, managers, and employees, but sometimes on ostensibly national security grounds - governments erect barriers to international commerce. The most notable are tariffs, quotas, domestic content restrictions, and reciprocity rules. In a 1991 survey, 45% of U.S. firms reported that trade barriers imposed by other countries presented the greatest impediment to selling abroad.

Exporters can absorb the added costs imposed by governments to some extent. In the case of quotas imposed by the importing nations, companies frequently shift to higher-priced items on which unit profits also are greater. This was the response of Korean and Taiwanese shoe producers in the late 1970s to numerical limits on the imports into the U.S. of shoes from those two countries.

In the early 1980s, American purchasers of Japanese-made automobiles often found that they were required to buy all sorts of high-priced extras and that they were paying as much as $2,000 above the sticker price for the reduced supply of Toyotas, Nissans, and other imported models. In that way, the Japanese producers actually benefited from the "voluntary" restrictions on their exports to the U.S. They increased their profits substantially in the face of quantitative limits. While Japanese car-makers exported about 30% of their auto production to the U.S. during that period, they earned approximately one-half of their profits from American sales.

When faced with more onerous obstacles to international trade, businesses draw on a variety of alternatives to direct exporting. They set up new manufacturing facilities (so-called greenfield operations) in the host nation. John Deere was one of many companies to establish production facilities in Europe during the 1950s in order to avoid the 18% tariff enacted following the formation of the European Common Market.

This type of response continues today. In 1991, Monsanto's low-calorie sweetener NutraSweet was hit with a very high duty in response to a charge of dumping in the European Community. In 1992, Monsanto entered into a joint venture with Ajinomoto, a Japanese food and pharmaceutical company, to build a plant in France to produce for the European market. One senior NutraSweet official described the situation very directly: "Although there may be evidence to the contrary, our experience only tells me that you have to be in Europe if you want to do business in Europe. . . . You can't sit offshore somewhere and ship your product in."

Many Japanese manufacturers moved the production of such items as textiles, watches, television sets, cameras, and calculators to facilities in Malaysia, Indonesia, Thailand, Singapore, and the Philippines in response to the restrictive trade practices of some of their major markets. Japanese automakers also are producing cars in the U.S. on a large scale. This approach provides the Japanese firms direct access to the markets of the local economies in which they produce and minimizes their exposure to adverse policies by the host government. It also permits them to export to markets in other nations that maintain barriers against products made in their home territory. For instance, Honda sells cars to Taiwan, South Korea, and Israel from its manufacturing plant in Ohio. Those three countries traditionally have prohibited the importation of automobiles directly from Japan.

Similarly, Northern Telecom, a Canadian telecommunications company, conducts business with Japan through its American subsidiaries, since Japanese firms are considered to favor U.S. over Canadian telecommunications entities. According to a Northern Telecom official: "The reality is that we probably could not have penetrated Japan out of Canada."

Businesses also respond by acquiring existing local companies. This has been a particularly important strategy for foreign firms positioning themselves in response to the integration of the European market. Many American and Japanese companies fear that the removal of internal regulatory and economic barriers in Europe will result in an increase in reciprocity requirements and local content restrictions. Thus, acquisitions increased steadily during the mid to late 1980s as firms sought to gain a foothold there. In 1990, for example, Emerson Electric purchased the French firm Leroy-Somer; General Electric acquired the United Kingdom's Burton Group Financial Services; American Brands bought out Scotland's Whyte & Mackay Distillers Ltd.; and Scott Paper purchased the Tungram Company of Germany.

Other alternatives that businesses frequently rely upon to develop positions in the markets of other nations include subcontracting production, purchasing locally, and developing products jointly with local firms.

To overcome political objections to goods coming from other countries, some multinational corporations set up so-called "screwdriver" operations - assembly plants using key components manufactured domestically and performing no research and development locally. Thus, the economic contribution in the host country is minimized. Japanese companies are especially fond of using this technique. One analyst has used the term "rainbow" to describe this: "The U.S. plant is situated here, the mother plant is situated over in Japan and nothing touches in between ... and the pot of gold is at the other end."

In a more overt move to reduce opposition to foreign firms taking away American jobs, Toyota announced in mid 1992 its plans to start buying parts from a U.S. competitor, Chrysler. Toyota will buy charcoal-containing canisters (used in emission control systems) for its Georgetown, Ky., factory, which produces the Camry. It also expects to export some of the canisters to Japan to use in its cars made there. In a less publicized manner, Chrysler has been manufacturing parts for Mitsubishi for many years. Ford and General Motors also are among Toyota's North American suppliers. Although the principal explanation for onshore production by Japanese producers is as a response to U.S. protectionism, many American observers believe that such investments also are a hedge against even more stringent measures and may even head them off.

Moreover, joint ventures, particularly those involving the operation of manufacturing facilities, often are necessary to overcome trade restrictions, especially in the case of the formation of protectionist trade blocs. This trend is evident in the aerospace and automobile industries, where every major company has formed alliances with foreign competitors. For instance, Ford has a joint venture with a local producer in Taiwan to assemble Festivas for sale in that market. An alliance involving Ford, Mazda, and Matsushita Electric of Japan manufactures air-conditioners for Fords and Mazdas sold in Japan. General Motors markets some of its vehicles in Japan through a three-way joint venture involving Suzuki and Nissho Iwai Corp.

While joint ventures and other cooperative strategies often are considered as second-best relative to exporting or the operation of a wholly owned facility, they do provide important benefits. These include, in addition to market entry, the advantage of working with a partner knowledgeable about the local situation, as well as the sharing of production costs and risks.

In some circumstances, firms may be able to export duty-free to countries possessing broad tariff policies in exchange for capital investments or for using local contractors or raw materials in the production process. A joint venture between General Motors and a state-owned automobile maker in Poland to manufacture cars domestically will provide a significant inflow of capital, technology, and expertise to the beleaguered Polish firm. In return, General Motors will be allowed to import into Poland a portion of its automobiles duty-free.

Responding to investment


On other occasions, firms face sharp limits to foreign ownership of local enterprises. This type of governmentally imposed roadblock has become more popular in a period when formal trade barriers have been reduced substantially and may include formal restrictions on investment or less formal, but often equally powerful, tax and regulatory advantages limited to local companies.

Even though mergers and acquisitions are the dominant modes of penetrating European markets, there exists considerable opposition to American takeovers of very large local firms, especially among the member countries of the European Community. To date, there have been few acquisitions by U.S. companies in Europe that amounted to over $1,000,000,000.

In Indonesia, no foreign company can buy a local one or set up a new one (except in a very few designated areas). As a result, as elsewhere in the Asian rim, international enterprises most often enter into joint ventures with local firms or, in extreme cases, literally give away nominal majority ownership. For these reasons, in Asia and Eastern Europe, joint ventures and other strategic alliances are the dominant modes used by foreign companies attempting to develop a presence in local markets. This is particularly true in the case of high-technology industries.

In the case of defense contractors, many of the cross-border alliances may be involuntary on the part of the foreign partner. In large measure, makers of advanced weapon systems enter into agreements with foreign firms in order to gain (or avoid losing) governmental customers. During the 1970s and 1980s, European governments demanded a greater role in the development of the military aircraft they were buying from the U.S. A counterpart was the Japanese desire to build up its aircraft manufacturing industry, as exemplified in the controversial FSX fighter project involving a joint venture between a Japanese manufacturer and a major American aerospace firm.

These demands for production (and often technology) sharing intensified at a time when the U.S. government was eager to reduce the development costs of its weapon systems and wished to encourage standardization, especially in NATO weapons. In 1986, Congress reinforced this trend by enacting legislation that encouraged multinational cooperation in weapons development.

Another strategy adopted by foreign nations has been to demand a greater role in the production of aircraft they were purchasing from American companies. Faced with the prospect that several European governments might try to develop an indigenous military fighter to rival the F-16, General Dynamics agreed to assign a major production role to domestic firms in prospective purchaser nations. This role included production of parts for planes sold to the U.S. Air Force. Aided by such arrangements, and with the backing of leading Belgian and Dutch aircraft firms, General Dynamics won the contract over strong competition.

In some circumstances, a host government may be willing to accept the construction, expansion, or acquisition of a local branch by an American company on the condition that the firm meets a specified performance requirement or provides another concession. Before IBM was allowed to increase its operations in Mexico, it agreed to set up a development center for semiconductors, purchase high-technology components from Mexican companies, and produce software for Latin America in Mexico.

In the case of more standard manufactured goods, other ways around investment barriers include entering into agreements with local firms that will produce the item under licensing arrangements. In some instances, firms that would prefer to export products manufactured in their home countries are forced to agree to license the manufacture to a business in the host country. While Japanese civilian markets are becoming more open to foreign investment (IBM and Texas Instruments own production facilities there), many companies still must rely on licensing and other cooperative contractual relationships between the parent and Japanese firms. For example, U.S. companies, such as Honeywell, RCA, and General Electric, often have been limited to engaging in licensing arrangements in Japan.

Moreover, Japanese firms have produced, under licensing from American firms, the McDonnell Douglas F-15 fighter, Boeing Chinook helicopter, and Lockheed P-3C. Similarly, companies in Taiwan have been licensed to manufacture the M-109 howitzer, FFG-7 class frigates, and several missiles. At other times, a production-sharing arrangement is required. A government-owned airline may require the manufacturer to buy designated amounts of locally produced parts.

In the case of services, franchising to a domestic enterprise serves a similar purpose to licensing in adjusting to barriers to direct investment. However, governments may insist that the domestic operator be given a majority control. For instance, South Korea generally discourages franchising unless the local partner is given at least 50% ownership. In addition, profits from the franchising business are taxed at 40%, and a 10.75% withholding tax is levied on royalties and dividends earned by the parent organization. Taiwan maintains similar restrictions, but seldom allows franchising agreements to extend beyond five years. It also taxes dividends and royalties at 35 and 20%, respectively.

In other parts of the world, especially the less-developed nations, public-sector deterrents to business take different forms. Governments on occasion restrict repatriation of earnings, or foreign businesses fear future expropriation of their assets. Governments also may restrict location, financing, and technology inputs, and require local sourcing of raw materials and rigid technical specifications.

Indirect barriers, such as inadequate patent protection laws, also may impede a firm's ability to market its goods successfully in a foreign country. Marsh-McBirney reports that the company especially has been hurt by the weakness of patent protection overseas. In particular, officials believe that its export business in Europe would double if its patented products adequately were protected there. In such circumstances, uncertainty as to future public-sector policies constitutes a major obstacle to investments by foreign firms.

Global enterprises interested in doing business in parts of the world characterized by great business uncertainty often set up affiliate or correspondent relationships with local firms. This minimizes risk and liability, but also profit potentials. Consider the case of Exxon, whose Venezuela operations were nationalized in 1975. Responding to a new political environment in that South American nation, the company has reopened an office in Caracas to pursue proposals to build and operate energy facilities with local partners under joint-venture agreements.

When other barriers have been imposed by governments in the more advanced economies, licensing arrangements can be made with domestic firms in exchange for market entry. These governmental obstacles may include local political or industrial pressures, local distribution systems strongly favoring home-produced products, and heavy transportation costs. Enterprises in advanced economies thus can respond to attractive overseas markets without directly penetrating them.

Companies that have difficulty introducing products in the home country due to delayed approval or stricter governmental requirements can license their products to firms in other countries in an effort to introduce them to markets more quickly. This practice is common to some American pharmaceutical firms. For example, Vestar and Genentech on occasion have introduced drugs in Europe before they were approved in the U.S.

A more fundamental response to burdensome domestic regulation is occurring in the petroleum industry. National policy keeps drilling rigs out of the Arctic National Wildlife Refuge, which the industry considers to be the country's best prospect for new oil exploration. A recently enacted energy bill also extends moratoriums on offshore drilling and the new clean-air rules make it more expensive and difficult to refine oil in the U.S.

As a result, U.S.-based energy companies have been expanding their overseas operations while cutting back their domestic activities. The number of drilling rigs searching for oil and gas in the United States declined from 4,530 at the end of 1981 to 596 in mid 1992. Total outlays for exploration and development in the U.S. by 30 large oil and gas companies fell four percent in 1991. Their investment abroad increased by 27% and totaled more than 50% higher than in domestic markets.

In many other instances - especially in the more developed nations - companies face high taxes and onerous regulatory costs. In some cases, the barriers may be rather informal in nature. When these obstacles to business occur in the home country, the enterprise can expand overseas. In more extreme cases, existing business operations are moved to a more favorable policy environment in another country. In the case of informal barriers, such as in nations whose traditions favor established companies over newcomers, the response by the transnational company often is to market through local distributors.

It is helpful under changing political circumstances to do business in several countries. In that event, when faced with rising government burdens in one nation, a firm can shift its high value-added activities to other nations in which it operates, specifically those with lower taxes and less burdensome regulation.

Export restraints usually are imposed by governments attempting to punish another country by applying sanctions against its trade. Compensating shifts often occur in the geographic distribution of goods from various exporting and importing nations. Companies in the target nation may supply or be supplied by firms in other countries that are not adhering to the sanctions; firms in the sanctioning nation may wind up selling to or buying from firms that are the former customers of the non-sanctioning countries.

For example, during the 1980 U.S. grain embargo against the Soviet Union, companies in Canada, Australia, Argentina, and the European Community increased their wheat sales to the U.S.S.R. American companies, in turn, shifted wheat to customers of these countries. Thus, the main impact of the embargo was to shift the international distribution of wheat sales, with little effect on their total amount.

It should be emphasized, though, that traditional business reasons also are involved in the choice among the available methods of penetrating foreign markets. Indeed, those business concerns - such as cost and transportation advantages - often may be the dominating influence.

Influencing government


In the years ahead, the combined power of economic incentives and technological change increasingly will have feedback effects on the decisions of voters and government officials as they develop new national (and regional) policies dealing with the global economy. In a basic sense, the mobility of enterprises - of their people, capital, and information - is reducing the power of government. Public-sector decision-makers increasingly are being forced to understand that they now have to become internationally competitive in the economic policies they devise. Governmental activities that impose costs without compensating benefits or reduce wealth substantially in the process of redistributing income undermine the competitive positions of domestic enterprises. The result is either the loss of business to firms located in other nations or the movement of the domestic company's resources and operations to more hospitable locations.

Political scientists and economists long have understood that people vote with their feet. They leave localities, regions, and nations with limited opportunity in favor of those that offer a more attractive future. In an era of computers, telephones, and fax machines, enterprises are far more mobile than that; information - that key resource - can be transferred in a matter of seconds, or less. The fear of losing economic activity to other parts of the world can be expected to reshape future domestic political agendas in fundamental ways.

Of course, not all governmental involvement in international business is of a negative nature. On many occasions, public-sector policies actively encourage foreign companies to invest, build new facilities, or otherwise participate in the local economy. Such supportive actions include tax abatements, tariff waivers, liberal credit terms, and reductions in burdensome regulation. For instance, as an incentive to invest in Hungary, that nation's government offered Ford a 10-year freeze on the payment of taxes.

Moreover - and often of transcending importance - business enterprises simultaneously take into account a great variety of traditional considerations. These range from differences in production and distribution costs to the limits of the firms' financial and organizational capabilities. In the move toward globalization, individual companies may experience rough sledding and reverse some of their foreign commitments.

The alliance between General Motors and Daewoo of South Korea went sour when Daewoo's desire to expand in local markets conflicted with GM's global objectives. Greater difficulties have arisen in the transitional economies of Eastern Europe and the republics of the former Soviet Union. Investors often do not know if they have legal title to the items they purchase. As a result, of the 2,000 deals Americans have made in Russia and the other republics, less than 100 are functioning.

In more developed markets, DuPont and Holland's Philips ended a cooperative agreement because of different goals. So did Borden, Inc., and Japan's Meiji Milk Products. Earlier, Bull of France, Siemens of Germany, and Philips abandoned their attempt to form a Europe-based computer alliance. Clearly, the interaction of regionalization and globalization will continue to generate winners and losers.

The tension between business and government is nothing new. It traditionally has existed between large private enterprises and the rulers of developing countries. This tension between governments generally - both those with developing and those with more advanced economies - and business firms is being exacerbated by the rapid rate of economic, social, and technological change.

Companies oriented to the international marketplace, in turn, have a variety of response mechanisms to draw upon. These range from exporting to acquiring other firms to licensing products and services to entering into strategic alliances with other business firms. Those choices often are influenced strongly by governmental policies and practices. These public-sector influences include actions by the nation in which the parent company is located as well as by the country in which the firm is trying to develop a new presence. The governmental actions range from the supportive, such as a tax incentive to invest in a specific region, to overt barriers, notably restrictions on imports and foreign investment.

There is another force involved that ultimately is likely to carry the day - the citizen as consumer. Consumers vote every day of the week in dollars, yen, Deutsche marks, pounds, francs, and lira. The same protectionist-oriented voters, as consumers, purchase products made everywhere in the world. They give greater weight in spending their own money to price and quality than country of origin. Moreover, they increasingly travel to, and communicate with, people in virtually every land. Consequently, businesses will continue to adopt innovative and effective responses not only to the barriers governments may erect, but also to the potential to turn a profit in a global economy.
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Author:Weidenbaum, Murray L.; James, Harvey S., Jr.
Publication:USA Today (Magazine)
Date:Sep 1, 1993
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