Rocky Mountain Chocolate Factory Preparing Financial Statements
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* The first post-war period (1945-1975) witnessed strong economic growth and gradual increase in globalization under the Bretton Woods institutions. What do we mean by “the Bretton Woods institutions” (Background Brief: Bretton Woods Institutions)? What role did the US play in setting up these institutions and what were its motives? The Bretton Woods Institutions take their name from a multilateral conference held in July 1944 at the Bretton Woods resort in New Hampshire. The narrow definition of Bretton Woods Institutions refer to the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), while they were only part of a much broader wave of international institutional innovation, including the World Bank Group, GATT, other multilateral development banks, UN, and other multilateral international organizations. Bretton Woods System was to create a multilateral institutional framework to avoid the inter-states conflicts of the interwar years.
It was also to assist in the reconstruction of a new international economic order after WWII. It was a collectively goods, a majority of which was provided by the US, to restore and secure a new world order. US played core role in the establishment, maintenance and development of the whole system. The primary motives include: 1. US believed the Bretton Woods System could help extend its allies front, and help restore the old Europe under massive destruction of WWII. 2. Bretton Woods System, as it took multilateralism as core principle, would be idealistic to settle down inter-states disputes and avoid a new world war. 3. Bretton Woods System would help coordinate collective action of member parties and prevent massive worldwide economic depression.
* Since the Global Financial Crisis (2008-2009), what are the most important changes that have occurred to the global system? Generally speaking, the world economy in the foreseeable future is going to be much more dependent on the developing world than the past. Convergence in income levels is likely to continue since the crisis, reflecting both the fair performance of developing economies and the poor performance of industrial countries. The reform on international macroeconomic and financial architecture requires active role of developing countries. Yet some questions remain. The first is whether major developing countries particularly China can become an alternative engine of the world economy. The second is the dynamics of world trading system and the transformation of center-periphery character.
* Review Background Brief No. 2, so you are familiar with the main periods of globalization. In what way does the Bretton Woods system (Period 3) develop as a reaction to the problems of the Interwar Period (Period 2)? During Period 3, the US shouldered the responsibility of international institution, coordinated the trade and financial issues and facilitated interstate cooperation. It is reaction to the lack of a hegemon and dominating force that fail to sustain the stability of international order in the Interwar Period. And gradual but steady liberalization of trade and financial controls also took place, when Keynesianism was triumphant to combat the depressions. In sum, a tightened international tie was constructed as US clearly assumed the leadership and more binding international organizations were established.
* What do we mean by GDP and how does it relate to the concept of economic growth? GDP means the total “value-added”, the sum of all the value-adding activity carried out in a given geographic territory in a certain time period. It is equal to the sum of the value of all final goods and services produced in a given economy. GDP is a useful measure of the total economy size in a country at given period. Therefore by referring to the changing rate of GDP we might also acquire the growth rate of overall economy.
* Be comfortable talking about factor endowments, factor abundance and factor intensity; be able to explain the overall (aggregate) production function that shows the relation between factors of production and output. What does the AK growth model lead you to expect about the relative growth of rich and poor countries? The factor endowment is the total stock of factors of production available to an economy at a given time. The factor abundance is decided by the supply relative to other factors (mostly to the population, human-capital abundance, land abundance, etc.). The factor intensity refers to the relative importance of one factor versus other factors in production of a given industry (labor-intensive, capital-intensive, etc.). The AK growth model can be defined as the function:
Y=A*K, Y is the output, A is the productivity (mainly dependent on technology), K is the capital. From the definition we know the function represents constant return to scales. Therefore there would be no convergence between the growths of developed countries and developing countries, with different starting capital and productivity.
* What are these flying geese, anyway?
The “flying geese” model: One economy, like the first goose in a V-shaped formation, can lead other economies toward industrialization, passing older technologies down to the followers as its own incomes rise and it moves into newer technologies. The comparative advantage of different countries is dynamic.
* Why is Justin Lin optimistic about the growth potential of the lower income countries? What policies does he advise? Mr. Lin’s optimism depends on the flying goose model and later-comer advantage. As he suggests, economic development is a dynamic process as countries strive to climb up the industrial ladder. The comparative advantage is thus transferred to late-comers, which can emulate predecessors with similar endowment structure and exploit the relatively abundant endowments. Now, China and some other countries are to upgrade their industrial structure, which leaves other developing countries an opportunity to fill in, especially labor intensive industries. He advised the developing country to follow comparative advantage in its industrial development and to tap into the potential of advantages of backwardness in industrial upgrading. Besides, the dynamic growth in China and other large emerging markets provide an unprecedented opportunity for the industrialization and dynamic growth in Africa and other low income countries.
* What is a “growth miracle”? What is a “middle income trap”? What is a “poverty trap”? Growth Miracle occurs when a country has a tremendous high GDP growth rate in a certain period. Middle Income Trap is an economic development situation, where a country which attains a certain income (due to given comparative advantages) will get stuck at that level. As wages rise, manufacturers often find themselves unable to compete in export markets with lower-cost producers elsewhere. Yet, they still find themselves behind the advanced economies in higher-value products. Poverty Trap means the poverty in a country is persistent and there is little economic growth over years. The situation is generally attributed to limited access to credit and capital markets, extreme environmental degradation (which depletes agricultural production potential), corrupt governance, capital flight, poor education systems, disease ecology, lack of public health care, war and poor infrastructure.
Trade and Commercial Policy
* What are factors of productions, factor abundance and factor intensity? How does the progress of the T-shirt through foreign trade, as described by Rivoli, fit in with an analysis of trade based on factor abundance and factor intensity? A factor of production is a basic resource that is used, but not used up, in the production process. It can be capital (physical capital/human capital), labor, and land. Answered above.
The process of making the T shirt:
1 The production of cotton
Admittedly, subsidizes, tariff and barriers did help keep comparative advantage of US cotton industry. But growing cotton is not exactly labor-intensive; it is becoming increasing technology intensive and calls for investment on R&D (e.g. genetically modified seeds). US is relatively abundant in capital, technology and arable land. 2 The production of cotton textile
The production process is highly labor-intensive. Labor force is comparative abundant in China, requiring lower wages than the United States. It is a race to the bottom. In recent years, the industrial transformation/ new labor law and other regulations lift the cost of labor force. Other more factor abundant countries, Vietnam and Pakistan took the place of China. 3 The recycle process and export to Africa
The recycle of cotton textiles is skill-intensive. It requires particular skill to distinguish the value of second-hand clothing accurately. Therefore US companies conduct the business.
* What is the relationship between underlying factor endowments and relative prices within a country? Abundant factor endowments have relatively cheaper prices within a country. However, in a highly integrated global market, the difference in prices tends to converge.
* Trade enables economies to take advantage of differences in factor endowment by trading and specializing in line with their factor endowments. Gains from trade come from increased opportunities for exchange, and from the ability to specialize (Rivoli, chapters 4-6).
* Can factor endowments change over time? What are the implications? Consider the various ways in which the United States has managed to maintain its comparative advantage in the export of cotton (Rivoli, chapters 1-3). The Flying Geese Paradigm helps explain the dynamics of factor endowments. The factor endowments can change over time when industry is upgraded, capital/technology is accumulated, demographic feature is changed, etc. The core principle in maintaining comparative advantage of exporting cotton is to keep high productivity at low cost. US producers utilized the abundant endowment in skilled-labor and land, invested large capita in machinery and other equipment and improved technology (e.g. GM seeds). It is true that US producers gradually lost the advantage on some abundant factor endowments, as slavery is not allowed and the labor cost is increasingly high, but they still managed to keep other abundant factor endowments to remain competitive.
* Trade changes relative prices in the domestic economy, so there are necessarily winners and losers from increased or decreased trade opportunities. Who are the winners and losers from trade? (Hint: the answer depends on initial factor endowments; it is not the same in capital- and labor-abundant economies). The winners are industry of abundant factors while the losers are industry of scarce factors. The trade would raise factor returns of abundant-factor industry and probably lower the costs, as cheaper imports are now available. The industry of scarce factors, however, must face foreign competitors whose factor endowment is relatively abundant, and the factor returns would be lower.
* The main instruments of trade policy are tariffs, quotas, subsidies, and non-tariff barriers. All of these have similar effects, in that they create differences between domestic prices and world prices. (Krugman and Obstfeld)
* The most common form of trade policy in the developing world has been “Import Substituting Industrialization (ISI).” What are the problems associated with this strategy? (Krugman and Obstfeld) The arguments supporting ISI are:
1. Infant Industry. Developing countries have potential comparative advantage in given industry but as new-comer it cannot compete with well-established industry in developing countries. So temporary support is needed. However, first it is not good to try to move today into the industries that will have a comparative advantage in the future. Second, protecting does no good unless it truly helps make industry competitive; there is the danger of “pseudoinfant” industry. At last, unless there is domestic market failure, government intervention should be avoided. Two arguments should be considered: the appropriability argument (the pioneers might create intangible/other social benefits that cannot be compensated) and the imperfect capital markets argument. 2. Promoting manufacturing industry.
First people before 1970s believed industrialization was necessarily based on a substitution of domestic industry for imports rather than on a growth of manufactured exports. Second import substitution directly benefited powerful established interest groups. Third the world economy was rigged against new entrants. Problems of the strategy:
1. Empirical study shows the gap is not narrowed.
2. The cost is high. Resources are extracted from factor-abundant industry to factor-scarce industry. Inefficient production scales. The unemployment and income divergence.
The Political Economy of Trade
* Interest group models of trade see trade policy as an exchange between politicians and constituents. What resources do constituents bring to bear on politicians? 1 Financial Contributions (Legal: Campaign contributions/ Illegal: Bribery, Corruption) 2 Lobbying, persuasion/biased information
3 Votes, as highly organized in disadvantaged industry
* Which groups are likely to be pro- and anti-free trade? (Hint: again, the answer depends on initial factor endowments; it is not the same in capital- and labor-abundant economies). Interest groups related to scare factor endowment industry/ import-competing sector would anti free trade. Interest groups related to abundant factor endowment industry/ exporters would pro free trade.
* Why might legislators delegate trade policymaking to the executive? What are the effects of such delegation? How do legislators control the president? WHY: it is a procedural mechanism to enhance the president’s credibility in negotiating complex multilateral trade agreements by streamlining the congressional approval process in return for enhanced congressional oversight. President is thus granted with more power in handling agreement of complexity and makes his promise to other negotiators. It is also a conditional grant of authority to President with certain constraints and oversight imposed. How to control:
1. Oversight procedures
2. Withdrawing the authority delegated to the President
3. Power of Ratification
* Destler provides a case study of trade policymaking in the US. Partisanship matters; Democrats have different concerns than Republicans. What issues do Democrats raise in these negotiations, and how are they influenced by the interests of their constituents? Democrats raised issues like international labor standards, implementation of multilateral environmental agreements, protections on pharmaceutical innovation, national security concern on ports and FDI that lead to “unfair” competition in free trade. The issues are linked with wage stagnation and growing income inequality in US; they are related to the interests of constituents, who are damaged in competition with foreigners.
* What are the main principles of the GATT/WTO system? What is non-discrimination? Does regionalism violate this principle (see Background Brief on regionalism)? The main principles of GATT/WTO are liberalization, reciprocity & bargaining and non-discrimination. Liberalization is a process of negotiated reduction of at-the-border barriers. Reciprocity & bargaining indicates the exchange of concessions that benefit all the involving parties; advanced states are not allowed to shape the nature of the trade agenda. Reciprocity is that any negotiated concessions should apply to all members equally on a most favored nation basis. Critics argue regionalism is inherently discriminatory: 1 they are diverting trade from the rest of the world toward favored regional partners (trade diverting). 2 complex international trade environment governed by dozens of separate agreements, each with different and often conflicting rules (Reconciling overlapping agreements). However proponents recognize there will always be trade diversion but it could be minimized after signing regional agreements, as setting agenda and acting as incentive for further multilateral trade talks (trade creating).
* The Uruguay and Doha rounds sought to reach “grand bargains” between advanced and developing countries. What are the issues of interest to each group of countries, and how do they reflect comparative advantage? The Southern Agenda: 1 continued liberalization of trade in goods of interest to developing countries. (Textiles and Apparel, Natural Resources, Tropical Products and Other Agricultural Products) 2 subsidies and dumping: tighten the rules on imposing restraints on trade. 3 improvements on dispute settlement through quasi-judicial processes that protect small countries. The Northern Agenda: 1 market access in goods but also trade in services, including non-discrimination and national treatment. (telecomm, air transport, and financial services) 2 trade-related aspects of intellectual property rights (copy rights, patents, trademarks, chip design). The comparative advantage of developing countries is raw material, labor-intensive export and other non-high value added goods. The comparative advantage of developed countries is services, capital/skill-intensive industry, high value added goods (high-tech, etc.)
* From your reading of the two press clippings, what were the factors that led to the breakdown of the WTO negotiations in 2008? The North and the South cannot reach consensus on lowering the barriers, cutting the subsidies and diminishing support on domestic incipient, non-competitive industries. Particularly, some issues are the protection on farmers of developing countries and the key food products. Foreign Direct Investment
* What is FDI? What are M and A’s? What is greenfield investment? How is FDI measured? FDI is the foreign direct investment. M&A represents Investment through Merging and Acquisition, where multinational corporations invest and own a business previously started/run by others. Greenfield investment is a form of foreign direct investment where a parent company starts a new venture in a foreign country by constructing new operational facilities from the ground up (often occurred in developing countries). FDI can be measured as the percentage of GDP, percentage of Gross Fixed Capital Formation, percentage of total world, percentage of total trade in merchandise and services, percentage of total merchandise trade, US Dollars or US dollars per capita.
* FDI occurs when there are competitive advantages that the investing firm has vis-à-vis local competitors. What are these firm-specific advantages? The core competency, including various tangible or intangible firm-specific assets. Say professional management, technology and patents, brand, marketing channels, logistics, inventory and supply chain management.
* Many global firms have recently picked a “core competence” within the value chain and “out-sourced” other activities, often to foreign locations. The value-chain can be disaggregated not only within countries, but across them, giving rise to international production networks. What are these networks? The networks are created via a division of labor guided by vertical strategies. The company recognizes the core competence and outsources other components of the product value chain to suppliers and other actors, in which contracts and transactions are needed. It seeks to exploit factors of production and resources at different locations having comparative advantage. And the extra cost of operating across borders should be compensated by the benefits provided by the networks, including market access, resources access and other low factor costs. The link of networks is to maintain sustainable competitive advantage and global competitiveness. A paradigm of network is:
* Lazonick thinks we were better off before corporations started outsourcing and “financializing.” Why does he say this? Do you agree? By contrast, the McKinsey Institute sees a world of win-win solutions based on outsourcing. Lazonick referred to financialization, as the performance of a company is evaluated by financial measures (e.g. earnings per share). The manifestation of the financialization of the U.S. economy is the obsession of corporate executives with distributing value to shareholders, esp. in the form of stock repurchases, at the expense of investment in innovation and creation of employment opportunities. And the open systems of outsourcing undermined the old-economy “rationale” and career employment within one company.
Lazonick believed, in sum, the new model exacerbated inequity and instability of US economy, and restricted the potential for economic growth. I partly agree with Lazonick’s comment on financial market. Indeed, the new model’s high dependence on perspective stock-market gains would probably cause massive venture capital and induce great fluctuation, which distorted the demand and supply of capital. However, outsourcing and specialization on core competency might be beneficial, as corporations could focus on what is competitive and allocate enough resources. The fluidity of capital and labor would optimize the chain of production. And it also helps to deal with the imbalance in world economy and provides incentive for corporations in developing countries to grow. As MKI pointed out, outsourcing would reduce the cost and increase revenues of the business, and the flexibility of labor market also ensures re-employment.
* Note that much trade is not only “intra-industry” but “intra-firm.’ What does this mean? The T-shirt book has some interesting examples of how intra-firm trade and the creation of international production networks in textiles affected trade policy preferences of the industry. Explain. Intra-firm trade is the trade between two subsidiaries of a company in different locations. The company might have an international supply chain of products and each subsidiary utilize local comparative advantage. For example, the T-shirt book mentioned the American Apparel Manufacturers Association once supported restrictions on foreign exports and was part of seed-to-shirt coalition. But as manufactures gradually give up manufacturing in the United States and build up business abroad, AAMA emerged with American Footwear Association to become AAFA, which is primarily pro-trade. Only by lowering restrictions could they fully utilize the advantage of intra-firm trade and the international production networks.
* Location-specific advantages include market size, labor costs, resources, policy environment, institutional environment, privatization and liberalization. From the standpoint of the firm, it might be looking for different kinds of location-specific advantages, depending on whether it is following a horizontal or a vertical investment strategy. Which kinds of location-specific advantages are likely to be more important for a horizontal-type investment strategy? For a vertical-type strategy? What explains these differences? For Horizontal-type: Most horizontal strategies are market-seeking in which goods or services are produced and sold in the host country. So the location-specific advantages are: 1 size of market (high per capita income, large population, rapid growth, etc.) 2 the role of policy (trade barriers might motivate horizontal strategy) For Vertical-type: Vertical Strategies seek to divide up the production process within the firm and shift parts of it to different locations, based on the comparative advantage and factor endowment.
The market can be anywhere. 1. Factor of production (e.g., labor) 2. Policy Environment 3. Political Environment The difference can be explained by the features of different business. Horizontal strategies apply fitly for the business that must be close to the market and the final market for business applying vertical strategies can be everywhere. Moreover, the calculations of costs and benefits might also influence the strategy chose; if replication of a business is formidably costly then the company might choose vertical strategies instead. Finally, different policies are crucial; sometimes barriers are incentive for horizontal instead of vertical-type investment.
* Is the Latin American business service case describing a horizontal or vertical strategy? How would you describe the international production network in a sector such as business services? It mainly describes vertical strategy. The corporations outsourced the service to Latin America where there is a comparative advantage in low-cost skilled workers. Business Services require technical support such as call/contact centers, legal services, etc. By outsourcing the business services the company can specialize on core competence, lower the cost of business and stay competitive.
* “Who Captures Value in a Global Innovation System? The case of Apple’s iPod.” And the answer is…? The largest gainers: Apple (its employees and shareholders) To a lesser extent: Japanese and Korean manufacturers of high value-added components. Least: the assembly (e.g. China) and other lower value-added components