Introduction

1. Introduction 3460.01 Notes: A.P. Palasvirta, Ph.D.

2. Comparative advantage • David Ricardo • Factors of production • Labor • Fixed assets • Buildings • Land • resources • Capital • Ability to attract financing • Technology • Intellectual capital 3460.01 globalization notes: a.p. palasvirta, ph.d.

3. Production migrates • Seeks lowest relative cost factors • Alberta increases taxes on gas and oil • Production migrates to Saskatchewan (lower cost) • Appendix 1A • Country A • Food cost of textiles = 1.67 in inputs • Textile cost of food = 0.6 in inputs • Country A specializes in textiles • Country B • Food cost of textiles = 3.75 in inputs • Textile cost of food = 0.2667 in inputs • Country B specializes in food 3460.01 globalization notes: a.p. palasvirta, ph.d.

4. Global Finance • Globalization • International financial system • Exchange markets • Banking and money markets • Bond and equity markets • Derivative markets • Foreign exchange exposure • transaction • Economic • Translation • Financial management of the multinational firm • Foreign direct investment • Capital structure & capital budgeting • Imports, exports 3460.01 globalization notes: a.p. palasvirta, ph.d.

5. Measuring Risk Factors • Exchange rates (linear regression) • Trend • Slope of trend line of time-series regression • Positive- currency depreciating • Volatility • Standard error of estimate of time-series regression • Low value - low risk • Affect on real exchange rates • Violation of purchasing power parity condition • Something real is changing 3460.01 globalization notes: a.p. palasvirta, ph.d.

6. Political Risk - Macro • Exists as a function of potential change in rules (laws pertaining to business) • Expropriation (Venezuela, Hugo Chavez) • Quick compensation at fair market value • War (Iraq, Afghanistan) • Protectionism • Increasing the barriers to trade • Tariffs (U.S. import tariffs on Canadian lumber) • Quotas (European restrictions on genetically modify food) • Subsidies (export subsidies to produce wheat, corn) • Regulatory (including labor & environmental standards in treaties) 3460.01 globalization notes: a.p. palasvirta, ph.d.

7. Political Risk - Micro • Those in power make the rules • redistribution of wealth and income • Monetary policy • Fiscal policy • Regulatory policy • Corruption • Soft corruption - political contributions • Hard corruption - bribes 3460.01 globalization notes: a.p. palasvirta, ph.d.

8. Corporate Governance (dispersed) • Inside governance • Stockholders • Concerned about value maximization • Board of directors • Subset of stockholders • Hire managers • Strategic decision making • Managers • Tactical decisions making (strategic) 3460.01 globalization notes: a.p. palasvirta, ph.d.

9. Market efficiency • Many buyers, many sellers • No market power, thick markets • Low or no transactions costs (taxes) • Transactions costs and taxes distort • Perfect information • Eliminates agency 3460.01 globalization notes: a.p. palasvirta, ph.d.

10. Efficient markets?? • U.S., Canadian, British • Market failures • Enron, etc. • Failure of corporate governance structure • Sarbanes Oxley • CEO, CFO sign off on financial statements • Audit, compensation committees external • Corporate officers cannot take loans from firm • Test their own financial controls against fraud 3460.01 globalization notes: a.p. palasvirta, ph.d.

11. Goals of corporate governance • Protect shareholder rights • Majority and minority • Protect stakeholder rights • Customers deserve good products and reasonable prices • Firms should be good citizens • Disclosure and transparency 3460.01 globalization notes: a.p. palasvirta, ph.d.

12. Corporate Governance (concentrated) • other arrangements internationally • Government (privatized utilities) • Institutions • Banks, hedge funds, insurance companies • Family enterprises • Family conglomerates (France, South America) • Consortiums • Keiretsus (Japan) chaebols (South Korea) 3460.01 globalization notes: a.p. palasvirta, ph.d.

13. Government ownership • China, Russia, Arab Emirates • Increasingly have huge resources to spend due to trade and/or oil (sovereign wealth funds) • UAE $875,000,000,000 • Norway $360 billion • Singapore (GIC) $330 billion • Saudi Arabia $300 billion • Kuwait $250 billion • China $200 billion • Singapore (Temasek) $59.2 billion • Libya $50 billion • Quatar $50 billion • Algeria $42.6 billion 3460.01 globalization notes: a.p. palasvirta, ph.d.

14. Problems with SWFs • Governments do not necessarily worry about the bottom line (maximizing profits/value) • Governments have political agenda?? • How much of what Russia and China do is politically motivated • Chinese exchange rate policy • Russian interrupting gas supplies to Europe • Central bank holdings • U.S. Dollar denominate t-bills • China approximately $1 trillion 3460.01 globalization notes: a.p. palasvirta, ph.d.

15. Corporate governance - concentration • Family owned conglomerates • South America, Asia, France • Families own a diversified portfolio of real assets • Bank ownership of equity stakes • Germany, Korea • Government ownership of equity stakes • Canada, China, Russia 3460.01 globalization notes: a.p. palasvirta, ph.d.

16. Corporate governance - concentration • Concentration of power • Markets for equities and debt are thin • Few buyers, few sellers • Stock price manipulation • Lack of transparency • Highly asymmetric information • Government often complicit with firms • Goods and service markets manipulated 3460.01 globalization notes: a.p. palasvirta, ph.d.

17. Outside governance influences • Equity markets ( concern Value) • Analysis and trading (information) • Stock price moves on information • Up means excess demand at current price • Down means excess supply at current price • Debt markets (concern risk) • Analysis and trading (information) • Debt prices move on • Inflationary pressures, exchange rate movements, central bank mutterings • Risk 3460.01 globalization notes: a.p. palasvirta, ph.d.

18. Outside governance influences • Hired guns • Accountants • Lawyers • Regulators • Stakeholders - Agency problems • Customers/management • Management/labor • Stock holders/management • Government/management 3460.01 globalization notes: a.p. palasvirta, ph.d.

19. Operating Internationally • Cultural differences • Corporate governance • Legal environment • Regulatory environment • Different currencies • Exchange rate risk • Hedging behavior • Forwards, futures, options, swaps 3460.01 globalization notes: a.p. palasvirta, ph.d.

20. Exchange rate • Simple ratio • Canadian dollar (cd) price usd • usd price of cd • http://fx.sauder.ubc.ca/etc/CADpages.pdf 3460.01 globalization notes: a.p. palasvirta, ph.d.

21. Exchange Rate • Complex concept • Equilibrium price at which supply equals demand • Demand for USD (by Canadians) • Canadians buying American • Importing goods • Buying U.S. securities • Supply of USD (by Canadians) • Canadians selling to Americans • Exporting goods • Attracting U.S. based investors 3460.01 globalization notes: a.p. palasvirta, ph.d.

22. Financial markets • Deregulation • Elimination of fixed brokerage fees • U.S. 1975 • England 1986 • Benefits • Lower transactions costs • Cross border listings • International financial market integration • More innovation • Disadvantages • More innovation • More opacity (lack of information) 3460.01 globalization notes: a.p. palasvirta, ph.d.

23. Financial markets • Disintegration • Mortgage backed securities • Tranches of mortgages bundled for sale in secondaryh markets • Housing bubble • Viral effects • Banking • Lack of proper capital adequacy relative to risk • Lack of oversight of new financial instruments • Other sectors • Lack of liquidity led to failures 3460.01 globalization notes: a.p. palasvirta, ph.d.

24. Financial markets • Reregulation • Capital adequacy • Erection of walls to reduce conflicts of interest • Commercial banking • Deposits insured by government • Investment banking • Reporting requirements • Insurance • Mutual funds • Increasing oversight (Madoff) 3460.01 globalization notes: a.p. palasvirta, ph.d.

25. Euro zone • 1999 • Austria,Belgium, Finland,France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spains • Benefits • Reduce exposure • Financial market convergence • Lower costs of borrowing • More depth, more liquidity • Disadvantages • 12 different fiscal policies 3460.01 globalization notes: a.p. palasvirta, ph.d.

26. Euro zone • Implosion • PIIGS (Portugal, Italy, Ireland, Greece, Spain) • Running large deficits (more than 10% of GDP) • Increasing large government debtt (around 100% of GDP) • No exchange rate depreciation to bail them out to make their products cheaper • Retrenchment • Germany & France bailing out the PIIGS • New regulations and enforcement 3460.01 globalization notes: a.p. palasvirta, ph.d.

27. Economic integration • Trade treaties • The European Union • North American Free Trade Association (NAFTA) • World Trade Organization (WTO) • Doho round trying to liberalize agricultural trade and intellectual property • Retrenchment • Protectionism • Labor regulations • Environmental regulations 3460.01 globalization notes: a.p. palasvirta, ph.d.

28. Multinationals • Business firms operating in multiple countries • Inputs (raw materials, intermediate goods (engines) • Financing alternatives • Labor & capital (outsourcing) • Product markets • Advantages • Economics of scale & scope • Purchasing power with suppliers • Research & development 3460.01 globalization notes: a.p. palasvirta, ph.d.

29. multinationals • Disadvantages • Loss of control • Different cultures • Country & corporate • Distance • Harder to supervise • Cost control • Quality control • Transportation costs • Different regulatory, political environments • Expropriation 3460.01 globalization notes: a.p. palasvirta, ph.d.