Economic environment

ACCA Director Author

Economic environment

Economic environment

Contents:

• Free Trade
• World Trade Organisation (WTO)
• Free trade area - European Union (EU)
• International monetary Funds (IMF)
• The World Bank (or the International Bank for Reconstruction and Development or IBRD)
• The Bank for International Settlements (BIS)
• Financial Crisis (in 2008)
• European Sovereign Debt Crisis
• The international regulation on money laundering
• Dark pool trading

Referenced syllabus: A.4

Exam hint

• Questions may involve in asking about roles of certain organisations such as WTO and IMF, as well as requiring students to comment on impacts on businesses.
• Questions in this area tend to be knowledge based, usually with little or no application to case questions.

Free Trade

This usually measures where there are no restrictions of import from or export to other countries.

Protectionism measures usually include:

• Tariffs – A tariff is a tax on products coming into the country and is used to restrict imports and raise revenue for the government.

Trade embargoes – In international trade and politics, an embargo is the prohibition of commerce and trade with a certain country.

Subsidy – A subsidy is a payment to a domestic producer who exports a good abroad/give subsidy to domestic producer to compete with foreign producers.

Administrative controls – A country could consider imposing onerous red tape and administrative procedures, ie export license on exporters.

Import quotas – An import quota directly reduces the quantity of a product that is imported and indirectly reduces the amount of money that the export producers receive. The main beneficiaries of quotas are the domestic producers who face less competition.

World Trade Organisation (WTO)

Roles of WTO:

• This was set up to continue to implement the General Agreement on Tariffs and Trade (GATT).

• The main aims are to reduce the barriers to international trade.

• It does this by seeking to prevent protectionist measures such as tariffs, quotas and other import restrictions.

• It also acts as a forum for negotiation and offering settlement processes to resolve disputes between countries.

• The WTO encourages free trade by applying the most favoured nation principle between its members, where reduction in tariffs offered to one country by another should be offered to all members.

Benefits to businesses of reducing protectionist measures:

• Make other nations reduce protectionist measures – as the country is reducing protectionist measures.

• Businesses will benefit from increased trade and economic growth – businesses will therefore specialize and gain competitive advantages in certain products.

• Benefit from trading internationally – compete more effectively on a global basis.

Drawbacks to businesses of reducing protectionist measures:

• Certain industries may not be protected – as industries need time to be competitive on a global scale, reducing protectionist may harm certain industries.

• Declining industries may be further declining if industries are not protected – a large scale of unemployment may take place as a result.

Free trade area - European Union (EU)

Aims of EU or free trade areas:

1. Remove trade barriers and allow movement freedom - The free trade area such as EU aims to remove barriers to trade and allow freedom of movement of production resources such as capital and labour.

1. Eliminate discriminatory practice - The EU also has an common legal structure across all member countries and tries to limit any discriminatory practice against companies operating in these countries.

1. Set external barriers - The EU build common external barriers to trade against countries which are not member states.

Benefits for businesses to operate in the EU:

1. Equal - able to compete on equal terms with rival companies within the EU.

1. May be more competitive than companies outside the EU - Companies outside the EU may find it difficult to enter the EU markets due to barriers to trade.

1. Common legal structure makes due diligence easier – this ensures the standards of products/services (such as food quality and packaging) apply equally across all the member countries. Therefore, due diligence of logistic networks used to transport the food may be easier to undertake because of common compliance requirements.

1. Easier to set up branches - Having access to capital and labour within the EU may make it easier for the company to set up branches inside the EU, if it wants to.

Merges and Acquisitions (M&A):

• the European Union (EU) will assess significant mergers and acquisitions’ (M&As) impact on competition within a country’s market.

• It will, for example, use tests such as worldwide turnover and European turnover of the group after the M&A. It may block the M&A, if it feels that the M&A will give the company monopolistic powers or enable it to carve out a dominant position in the market so as to negatively affect consumer choice and prices.

• Sometimes the EU may ask for the company to sell some of its assets to reduce its dominant position rather than not allow an M&A to proceed.

Tutorial note:

Similar other free trade areas also include The European Free Trade Area (EFTA) (established in 1959, set up by UK; Sweden; Norway; Switzerland; Austria; Denmark; Portugal); the North American Free Trade Agreement (NAFTA) (established in 1994, set up by Canada, the USA and Mexico).

Exam question – Dec 2014 Q3 (a)

Discuss the aims of a free trade area, such as the European Union (EU), and the possible benefits to Riviere Co of operating within the EU. (5 marks)

International financial institution - International Monetary Funds (IMF)

The head office of IMF is in Washington.

Roles of IMF:

1. Oversee the global financial systems - in particular to stabilise international exchange rates, help countries to achieve balance of payments and facilitate in the country’s development through influencing the economic policies of the country in question.

1. Offers temporary loans - from member states’ deposits, to countries facing severe financial and economic difficulties. These temporary loans are often offered with different levels of conditions or austerity measures.

1. Conditions to loans - the IMF often requires countries to adopt strict austerity measures such as reducing public spending and increased taxation as conditions of the loan. This is because it believes that in order to regain control of the balance of payments, the country should take action to reduce the level of demand for goods and services. However, these deflationary pressures may cause standards of living to fall and unemployment to rise, ie people’s disposal income reduces.

How austerity measures impacts on businesses:

1. Spending more on marketing - some companies may have to spend proportionally more on marketing and possibly offer more discounts and other customer incentives in order to stay competitive and to maintain market share. This additional cost would hit their profit levels negatively.

1. Businesses need to review their cost structure – so that to survive or gain profits during this period.

International financial institution - The World Bank (or the International Bank for Reconstruction and Development or IBRD)

The head office is in Washington.

• Aim to supplement private finance and lend money on a commercial basis for capital projects.

• Loans are usually direct to governments or government agencies, for a long-term period of over 10 years (typically 20 years).

• The World Bank's funds are obtained from capital subscriptions by member countries of the IMF, its profits, and borrowing.

International financial institution - The Bank for International Settlements (BIS)

• BIS members include central banks from different countries and it acts as a lender to other central banks of last resort.

• BIS is also a trustee for IMF in loaning to members.

• Central banks in different countries:

• The Federal Reserve (the USA)

• The Bank of England (the UK)

• The European Central Bank (the EU)

• The Bank of Japan (Japan)
• Central banks in different countries are responsible for setting up monetary policy:

• Open Market Operations – provide or take back funds to/from commercial banks

• Interest rates policy

• Reserve requirement
• By reducing/increasing reserve requirement, commercial banks could lend more/less money to entities.

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