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Countertrade: A theoretical and empirical investigation

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Countertrade: A theoretical and empirical investigation

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Content COUNTERTRADE A THEORETICAL AND EMPIRICAL INVESTIGATION by Abla Abdel-Latif A Dissertation Presented to the FACULTY OF THE GRADUATE SCHOOL UNIVERSITY OF SOUTHERN CALIFORNIA In Partial Fulfillment of the Requirements for the Degree DOCTOR OF PHILOSOPHY (Economics) August 19 88 UMI Number: DP23345 All rights reserved INFORMATION TO ALL USERS The quality of this reproduction is dependent upon the quality of the copy submitted. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if material had to be removed, a note will indicate the deletion. UMT Dissertation Publishing UMI DP23345 Published by ProQuest LLC (2014). Copyright in the Dissertation held by the Author. Microform Edition © ProQuest LLC. All rights reserved. This work is protected against unauthorized copying under Title 17, United States Code ProQuest LLC. 789 East Eisenhower Parkway P.O. Box 1346 Ann Arbor, Ml 48106-1346 UNIVERSITY OF SOUTHERN CALIFORNIA THE GRADUATE SCHOOL UNIVERSITY PARK LOS ANGELES, CALIFORNIA 90089 PA.R £c % A \3 ? This dissertation, written by ABJLA A B . D K J L . T : . L . A . T ! j r . H . under the direction of h..%x. Dissertation Committee, and approved by all its members, has been presented to and accepted by The Graduate School, in partial fulfillm ent of re quirements fo r the degree of D O C T O R O F P H ILO S O P H Y Dean of Graduate Studies Date . ju 1 111,t < t 1988 _ DISSERTATION COMMITTEE Chairperson To my mother and father whose love, kindness, and constant encouragement have made it all possible ACKNOWLEDGMENTS First of all, I would like to express my sincere appre ciation and gratitude to my dissertation supervisor. Dr. Jeffrey Nugent for the important role he played in the com pletion of this work. Ever since I’ve known him, six years ago, he has been very encouraging and supportive. His friendly nature, good sense of humor and care for his stu dents that goes beyond the academic level, have made the PhD program a less horrifying experience. Last but not least, I am thankful for his invaluable guidance and thoughtful suggestions which have greatly improved the quality of this work. My thanks are also due to the other committee mem bers: Dr. J. Elliot, Dr. T. Kuran, Dr. I. Novos and Dr. J. Odell, for their time and cooperation as well as for sharing my interest in the topic of this dissertation. I also wish to express my gratitude to all the Egyptian offcials who have provided me with information on counter trade in Egypt. They have all been very cooperative and encouraging and thus made the hard job of collecting infor mation relatively easy. I particularly name Eng. Mohamed Abdel Wahab, the Minister of Industry; Mr. Fouad Sultan, the Minister of Tourism; Mr. Kamal Hilaly, the President of El Nars Export Import Company; Eng. Ezeldine Hekal, the Presi dent of El Nasr Automotive Manufacturing Company; Mr. Nasr iii I _ _ _ _ _ _ J, Sheta, the President of the Arab Company for Transistor Radio and Electronic Equipment; and Or. Atef El Biblawi, the President of the Egyptian Bank for Export and Development. My sincere gratitude and appreciation are also due to my father, Eng. Mohyeddine Abdel Latif, who has arranged for all these interviews and has also shared his expertise in trade and industry in Egypt for a clearer understanding of the Egyptian experience with countertrade. Without his ef forts this particular portion of the study would have never come through. My thanks are also due to Or. Demos Vardiabasis, Pro fessor in Pepperdine University and countertrade consultant, for valuable information on the attitudes of Western firms towards countertrade; to Dr. Mario Tello, who visited OSC two years ago, for some interesting early suggestions on the nature of the theoretical portion of this study; to Dr. Galal Amin, Professor at ADC, for helpful comments on this work as well as for his general support and encouragement that goes back to my early years in college; and to Mrs. Sue Taha, Senior Vice President of Security Pacific Bank for providing me with valuable information on countertrade, as well as for her considerable support. I also wish to extend my thanks to the Cultural and Educational Bureau of the Embassy of the Arab Republic of Egypt through which finan cial support for this work has been channeled. iv Finally, I could never forget the role played by my family in accomplishing this work. I would particularly like to thank my husband, Bassel, for being extremely help ful and supportive as he stood by me even though he has been struggling with a PhD of his own. His sincere love and encouragement have helped me overcome many of the obtacles 1 encountered during the last six years of my life. As for my mother, her love and cheerful nature have always managed to wash away all my worries. I would particularly like to thank her, however, for her considerable help in the criti cal period following the birth of my second baby. As far as my mother and father are concerned the dedication of a mil lion dissertations would not return even a small fraction of what they've done for me. v TABLE OF CONTENTS Page DEDICATION .............. ii ACKNOWLEDGMENTS.......................................iii LIST OF FIGURES........................................xii LIST OF TABLES.........................................xiv ABSTRACT .............................................. . CHAPTER 1 INTRODUCTION................................ .. 1.1 Objectives.................................. .. 1.2 Motives - ................................. .. 1.3 Format of the Presentation................... 7 CHAPTER 2 FACTS ABOUT COUNTERTRADE......................9 2.1 Its Definition............................... .. 2.2 Its Magnitude........... 11 2.3 The Main Forms of Countertrade............... 13 2.4 The Origin of Countertrade ................ 17 2.5 Economic Pressures for Countertrade ........ 18 2.6 Countertrade Practices in Various Regions of the World....................... -.21 CHAPTER 3 OFFICIAL ATTITUDES TO COUNTERTRADE: BETWEEN ACCEPTANCE AND DENIAL................30 vi TABLE OF CONTENTS (continued) 3.1 The U.S. Government Attitude . . . . .......... 31 3.2 The Attitudes of European Governments..................................34 3.3 The Case for Military Offsets................ 36 3.4 The OECD, GATT and IMF................... 37 CHAPTER 4 EGYPTIAN CASE STUDY.....................41 4.1 Why and How Egypt Uses Countertrade.................................42 4.1.1 The Economic Atmosphere that Encouraged Countertrade in Egypt................................ 42 4.1.2 The Formalization and Regulation of Countertrade.......................44 4.2 Barter Agreements.......... .45 4.2.1 Today's Barter Agreements versus the Old Bilateral Clearing Agreements...................45 4.2.2 Barter Agreements Signed in (1985-1987) . . ............. 49 4.3 Counterpurchase Agreements................. 54 4.3.1 The NEC Tourism Project in Egypt . ......... .54 4.3.2 The General Motors Project in Egypt......................56 4.4 An Evaluation of the Egyptian Experience with Countertrade and a Look at its Future.......... . 64 vii TABLE OF CONTENTS (continued) CHAPTER 5 ROMANIAN CASE STUDY.........................71 5.1 The Official Attitude of Romania Towards Countertrade.........................73 5.1.1 The Environment for Countertrade in Romania............................73 5.1.2 The Mandating of Countertrade in Romania............................74 5.1.3 Government Agencies Actively Involved in Countertrade ............ 75 5.1.4 Most Prevalent Forms of Countertrade in Romania............................77 5.2 Countertrade in Romania Based on the Experience of Various Western Companies . ........................79 5.2.1 Countertrade Requirements _in Romania......................... . 79 5.2.2 Goods and Services offered for Countertrade in the East Bloc in General and Romania in Particular . . .80 5.2.3 The Factors Behind Romania's Reputation as a Tough Bargainer in Countertrade.......................85 5.2.4 The Countertrade Contracts and Other EECs ..........................87 5.3 Industiral Cooperation Between British Aerospace and Romania ...................... 89 5.3.1 The Romanian Market (1967 to 1973).............. 90 5.3.2 The Romanian Market (1973 to 1976)...................... 95 5.3.3 The Romanian Market (1976 to 1979).................. 97 viii TABLE OF CONTENTS (continued) 5.3.4 Current Operations .................. 98 CHAPTER 6 THE ATTITUDE OF WESTERN FIRMS TOWARDS COUNTERTRADE...............................105 6.1 How a Typical Firm Plans for Trade............106 6.2 "Defensive" and "Offensive" Firms ............108 6.2.1 Motives for Engagement in Countertrade .........................109 6.2.2 The Decision Making Process of "Defensive" and "Offensive" Firms................................113 6.2.3 What Types of Firms Belong to Each Category........................114 6.2.4 Assets Needed by a Firm to Engage in Countertrade Transactions .......... 116 6.3 Industrial Cooperation Between Massey-Ferguson-Perkins LTD and Poland . . . 121 6.3.1 The Purpose of the Agreement.........122 6.3.2 The Details of the Agreement.........122 6.3.3 Motives of the Agreement............. 123 CHAPTER 7 WELFARE IMPLICATIONS OF COUNTERTRADE- MODEL I ....................................131 7.1 The Effects of Licensing and DFI on LDC Welfare.............................133 7.1.1 Introduction and Basic Assumptions........................ 133 7.1.2 The Basic Model...................... 134 7.2 The Effects of Countertrade, Licen sing and DFlon LDC Welfare.............. . 139 ix TABLE OP CONTENTS (continued) 7.2.1 The Introduction of Countertrade into the Basic Model . .139 7.2.2 The Countertrade Model (Model I ) ............................140 CHAPTER 8 WELFARE IMPLICATIONS OF COUNTERTRADE- MODEL I I .........................................160 8.1 The Differences Between Models I and I I ....................................160 8.2 Countertrade Model II ...................... 162 8.3 Duopolistic Market Structure .............. 167 8.4 Cobb-Douglas Production Function .......... 171 CHAPTER 9 COUNTERTRADE FROM THE MNE PERSPECTIVE AND THE EXISTENCE OF EQUILIBRIUM......................................189 9.1 The Introduction of MNEs into Countertrade Models I and I I ................189 9.1.1 Case One: Monopolistic Market Structure and Fixed Coefficient Production Function- Countertrade Model I I .............................191 9.1.2 Case Two: Monopolistic Market Structure and Fixed Coefficient Production Function- Countertrade Model 1...............................194 9.1.3 Case Three: Duopolistic Market Structure and Fixed Coefficient Production Function ................ 196 9.1.4 Case Four: Monopolistic Market Structure and Cobb-Douglas Production Function .............. . 198 x TABLE OF CONTENTS (continued) 9.2 Equilibrium and the Relevance of Transactions Cost Theory . . ................200 9.2.1 When an Equilibrium Is Reached.......... 200 9.2.2 Transactions Costs'* and the Choice Between Equilibria .......... 202 9.3 Conclusions of the Model and Reflections on the Case Studies..............207 CHAPTER 10 CONCLUSIONS AND SUGGESTIONS FOR FURTHER RESEARCH..................................220 10.1 Conclusions of the Study...................220 10.2 Suggestions for Further Research...........226 REFERENCES............................................230 APPENDICES............................................235 A. A Sample of Barter Contracts in Egypt......................................235 b. Proposal for the NEC Project in Egypt.....................................241 c. Sample of Countertrade Contracts in Romania ..................... 246 xi LIST OF FIGURES Figure Page 2-1. Countries Involved in Countertrade . . . 27 6-1 • A Typical International Marketing Strategy by a Western Company .... 128 6-2. The Decision Making Tree for a Defensive Firm ................... 129 1 H • Countertrade Model I: The Relationship Between the Elasticity of Demand and Qi and Q2 ....................... 7-2. Countertrade Model I: The Relationship Between the Elasticity of Demand and Blc/Bl and Blc/bs .................................... 7-3. Countertrade Model I: The Relation ship Between Y and Qi and Q2 .................. . 158 7-4. Countertrade Model I: The Relationship Between and the Ratio of Benefits . . a • . 159 8-1. Countertrade Model II: The Relationship Between the Elasticity of Demand and Qi and Q2 ....................... 00 I to * Countertrade Model II: The Relationship Between the Elasticity of Demand and Blc/Bs and Blc/bL............... 180 8-3. Duopoly Market Structure: The Relationship Between the Elasticity of Demand and Qi and Q2............................. 181 8-4. Duopoly Market Structure: The Relationship Between the Elasticity of Demand, blc/bs• blc/bl and bl/bs ................ 182 8-5. Comparison Between Monopoly and Duopoly: Relationship Between the Elasticity of and Q21 and Q22..................... The Demand xii LIST OF FIGURES (continued) 8-6. Cobb-Douglas Production Function: The Relationship Between the Elasticity o£ Demand and Qi and Q2.................. 184 8-7. Cobb-Douglas Production Function: The Rela tionship Between Labor Elasticity o£ Output and Qi and Q2............................... 185 8-8. Cobb-Douglas Production Function: The Rela tionship Between the Elasticity o£ Demand and Blc/Bs and Blc/Bl ....................... 186 8-9. Cobb-Douglas Production Function: The Rela tionship Between Labor Elasticity of Output and BLc/Bg and B^c/Bl ........................187 8-10. Cobb-Douglas Production Function: The Rela tionship Between the Elasticity of Demand and Bic/Bs...................................188 9-1. Case One: The Relationship Between the Elasticity of Demand and the Ratio of Profits......................... 213 9-2. Case Two: The Relationship Between Y and the Ratio of Profits............ 215 9-3. Case Three: The Relationship Between the Elasticity of Demand and the Ratio of Profits......................................216 9-4. Case Four: The Relationship Between the Elasticity of Demand and the Ratio of Profits.............................217 9-5. Case Four: The Relationship Between Labor Elasticity of Output and the Ratio of Profits.............................218 xiii LIST OF TABLES Table Page 2-1. Barter of Agricultural Commodities Between LDCs..................................... 28 2-2. Western Chemical Compensation Agreements With Eastern Europe and the Soviet Onion.........29 4-1. Egypt: Export-Import Ratio for the Period 1970-1983.................................68 4-2. Barter Agreements Between Egypt and Various Other Countries (1985 & 1986).................. 69 4-3. Barter Agreements Between Egypt and Various Other Countries for 1987.......... 70 5-1. Romania: Trade With the West and LDCs. . . . . . .102 5-2. Romania: Gross and Net Hard-Currency Debt......... 102 5-3. Value of Western Exports to the Eastern European Countries Under Buy-Back Arrangements....................................103 5-4. Planned Eastern Exports Onder Buy-Back Arrangements Signed 1969-1980. .................104 6-1. The Motivations of Western Firms that Result in Long-Term Arrangements................130 7-1. The Relationship Between y , B^c/Bl and BLC/BS ..................................... 155 xiv ABSTRACT OP THE DISSERTATION Countertrade is a new form of international trade that has been gaining a lot of attention from the business commu nity but virtually none from economists. Countertrade is generally defined as trade that requires the linking of import and export transactions. The purpose of the disser tation is to partially fill the gap that has arisen between the magnitude and pervasiveness of this unconventional method of trade and the dearth of economic analysis on it. Within this overall purpose, the study has three more specific objectives: 1) to describe clearly and objectively countertrade including identifying its various forms, its magnitude and importance and the motives of countries for engaging in it, 2) to analyze the attitudes, motives and objectives of the most important parties involved in coun tertrade and provide empirical evidence whenever possible, and 3) to formally analyze some important effects of coun tertrade, especially those on the welfare of LDCs and MNEs. The results of our analysis reveal countertrade to be _ — ~ ~ ~ ‘ not necessarily as harmful as it is usually argued to be. IndeedVunder prevailing conditions, it would seem quite beneficial to LDCs and could be even more soif it were appropriately regulated and understood. XV CHAPTER 1 INTRODUCTION "Countertrade is a return to archaic forms of business, and a disease that should be stopped before it spreads all over -the world. Money was invented to replace barter and therefore barter should not be allowed to replace money." (Business International, 1983) p.232 What is countertrade? How widespread is it? On what grounds is it so brutally attacked as we see in the above quotation? At present, there seem to be questions forjwhich there are few if any answers. Ironically, those who are knowledgable about countertrade and those who are in a po sition to either agree or disagree that it is a "disease" to be eradicated are not economists, but rather businessmen and politicians who typically are concerned with but one facet of countertrade. Although there is general agreement on its definition, namely as trade involving some kind of condi tional link between import and export flows, countertrade is 'a subject enshrouded in controversy with supporters on one side and attackers on the other. Proponents of countertrade see it as a flexible and 1 efficient means of sustaining previously achieved trade lev els and of redressing deteriorating economic conditions. It is also seen as a tool for advancing the international division of labour. Detractors of countertrade, on the other hand, give arguments like the one in the quotation above (Banks, 1983). Among the detractors o£ countertrade are important international agencies such as the OECD, IMP, GATT, and governments such as those of the US and most western countries. On the other hand, the USSR and all the Eastern European countries (EECs) always have been, and still are, strong supporters of countertrade (Welt, 1984a; Verzariu, 1985). As for the developing countries (LDCs), beginning in the early 1980's, they have become more and more involved in countertrade, primarily in order to overcome problems aris ing from their shortages of foreign exchange. However, de spite their involvement, LDCs are still not sure they under stand how countertrade affects their economies relative to other forms of trade not involving links between imports and exports (Welt, 1984b; Interviews in Egypt). This dilemma is mainly attributable to the superficial and unsubstantiated arguments that have been made by both the supporters and the opponents of countertrade. Of particular importance is the strong political attitude against countertrade held by vari ous influential international agencies such as the OECD and IMF. 1.1 Objectives The general purpose of this dissertation is to partial ly fill the analytical gap caused by the neglect of counter trade on the part of economists despite its large and ever growing significance and role in the world economy. Within this overall purpose, the study has three more specific objectives: 1) to describe countertrade clearly and objec tively including identifying its various forms, its magni tude, the economic pressures for its existence and its prac tices in various regions of the world, 2) to analyze the attitudes, motives and objectives of the most important par ties involved in countertrade and to provide empirical evi dence whenever possible, and 3) to formally analyze some of the theoretical aspects of countertrade, in particular, the effects it has on the welfare of both LDCs and multinational enterprises (MNEs). 1.2 Motives The motive behind the first two objectives of this study is to understand countertrade. By distinguishing its various forms and closely analyzing the various motives, 3 attitudes and extent of involvement of the various parties engaged in countertrade, we can form a complete picture of this unconventional method of trade; a picture that reflects its real nature and significance in world trade. It is also useful in pinpointing any possible risks or problems associ ated with its use. The attitudes of Western governments and various inter national organizations towards countertrade are not only interesting in their own right but also reveal some apparent contradictions between their official and unofficial posi tions. Similarly, the various attitudes of the Western com panies towards countertrade and the motives behind them help explain their reactions to the demand for countertrade. They are also useful in evaluating the claim in the litera ture that Western companies are coerced into countertrade and that they necessarily make losses. To temper the rhetoric that enshrouds the practice of countertrade, this study features two individual country case studies. The case studies yield insights that may be of use in the design of policy on countertrade. This is impor tant since at present there are no rules, patterns or blueprints for the design of countertrade. The case studies are also useful in illustrating the wide variety of types of countertrade and in overcoming the dearth of reliable de scriptive material on countertrade. The few existing stud- 4 ies deal primarily with Eastern European countries (EECs), the earliest to be involved in countertrade, and, less fre quently, some Latin American countries, probably because of their proximity to the DS in which most of the limited information on countertrade is published (Pisar, 1970; Verzariu, 1980; OECD, 1981; Paliwoda, 1981; Business Inter national, 1983; Hodara, 1984). The inadequacy in the availability of case studies is attributable to the the inability of existing trade data to distinguish between unlinked trade and countertrade, the confidentiality of most countertrade transactions and the high cost of gathering information based on interviews with officials in various countries. The country case studies, namely Egypt and Romania, have been chosen so as to be representatives of EECs and LDCs, respectively. While the case study on Egypt relies almost entirely on information obtained by the author in various interviews with government officials, the Romanian study relies on scattered published materials. The reasons for theoretically analyzing the effects of countertrade transactions on LDCs and MNEs, which is the third major objective of the study, are several. First, in the absence of adequate knowledge on the part of LDCs as to how countertrade affects their economies, other than pre serving hard currency, and of how the welfare effects of this form of trade compare with those of other unlinked forms of trade, appropriate policy decisions are unlikely to be made. Second, the sweeping but unsubstantiated claim in the literature that Western companies need to be coerced into countertrade and that this results in financial losses has impeded the accumulation of accurate knowledge concern ing how countertrade really affects the interests of the Western partner, typically a MNE. Moreover, the special nature of countertrade in its industrial compensation form, which is the focus of the analysis in the theoretical portion of this study, gives it considerable relevance and potential importance in the fu ture development of LDCs. Following the OECD's classifica tion system, industrial compensation is one of the two main categories of countertrade (commercial compensation being the other). Industrial compensation involves the sale of technology, plant or equipment through a contractual commit ment on the part of the seller to purchase a certain quanti ty of products that are produced by or derived from the original sale. The interlinking of these two transactions: the import of technology and the export of goods, implies that industrialization can be accomplished without exerting as much pressure on the balance of payments. The interlink ing of import and export transactions under industrial com pensation is also interesting and of potential importance as 6 a means of creating a long term relationship of mutual in terest between MNEs and LDCs, a relationship that could alter the incentives of the MNE and its usefulness to LDCs. 1.3 Format of the Presentation This study is organized as follows: chapter 2 presents some basic facts about countertrade such as those concerning its various forms, magnitude and practices. It discusses the economic pressures for its existence and as a result helps identify the general context in which we are studying this unconventional form of trade. Chapter 3 discusses the official and unofficial attitudes of various Western govern ments and international organizations like the OECD, GATT and IMF towards countertrade and provides evidence for the contradictions involved. The two country case studies, Egypt and Romania, are the subjects of chapters 4 and 5, respectively. Details on specific countertrade transactions and their implications are provided in both cases. Appen dices A, B and C include the contracts for some of these transactions. The attitudes and motivations of Western firms towards countertrade are the focus of chapter 6. Chapters 7 through 9 present the theoretical portion of the study. Partial equilibrium techniques are used to investi gate the comparative effects of countertrade, licensing and direct foreign investment in subsidiaries (DFI) on both LDCs 7 and JHNEs under various assumptions. The joint decision mak ing of LDCs and MNEs in choosing among the three available options and the relevance of transaction cost theory are also discussed. Finally, chapter 10 provides the conclusions of this study and various suggestions for further research. We finally note that all figures and tables referred to in this study are provided at the end of each chapter. CHAPTER 2 FACTS ABOUT COUNTERTRADE The GATT was conceived in the spirit of opening up world markets and allowing for gradual participation of all countries in the benefits of trade. Its basic tenet has always been that to achieve the benefits of a world trade system, bilateral transactions based on non economic consid erations must be replaced by a nondiscrimanatory, multilat eral approach with transactions completed on the basis of economic efficiency. While no one can deny the advantages of free trade, as identified in the GATT framework, it is important to note that these advantages and benefits are conditional on the existence of an adequate monetary system and the absence of barriers to trade. Unfortunately, however, today's interna tional trade environment is plagued with barriers and sec toral trade restricitions that impede the path of free trade especially for LDCs. It is given this environment, the in terdependence of today's world nations and the shaky world wide financial situation, as we explain in more detail below, that countertrade appears as an additional alterna tive and it is in this general context that we are studying it here. The purpose of this chapter is to present as clear and 9 complete a picture as possible of countertrade. The magni tude of countertrade, its various forms, the economic pres sures for its existence both in the past and in the present and how it is practiced in various regions of the world are among the important issues discussed here. 2.1 Its Definition While because of the newness of countertrade the termi nology about its forms has not yet been standardized, there is general agreement on its definition. According to the OS Department of Commerce (1978), a countertrade transaction is one in which a seller provides a buyer with deliveries^and contractually agrees to purchase goods from the buyer equal to an agreed upon percentage of the original sale values. Given this general definition, one can see how GATT, OECD and other international organizations view countertrade as "trade without money" or barter (Welt, 1985). However, such a definition is far from precise for several reasons. First, countertrade does not necessarily require that the import and export flows should be equal. Second, in countertrade the countries involved in the import transaction are not necessarily the same as those involved in the export trans action. The restricted definition of countertrade as barter generally applies to the older bilateral forms of counter trade (Hodara, 1984). Generally speaking ,however, counter trade can make much fuller use of the international network 10 of commercial and financial linkages that have been estab lished in the last three decades in order to multilateralize transactions and include additional parties located in very different countries. Last, but by no means least, the modes of countertrade most practiced today, such as counterpur chase and industrial compensation, seldom -follow the re stricted definition (Verzariu, 1985). 2.2 Its Magnitude One problem in assessing countertrade is obtaining a clear picture of its true global dimension. Estimates vary concerning the number of countries involved in countertrade and the proportion of world trade comprised of countertrade. Most of the problems of quantification stem from the failure of governments to record linked bilateral trade as a separate entry in their international accounts, and the ab sence of requirements for Western manufacturing companies to report countertrade transactions as a separate category in their disclosure statements. Another factor is the fact that much countertrade is handled by independent trading houses, which generally (and, often, are even required to) keep details of trading volumes and trading partners as secret as possible (Welt, 1984). Estimates of the percentage of countertrade in world . * trade vary from 5% to 30%; the share of countertrade is thought to be as high as 50% in some kinds of East-West 11 trade. The London-based Economist estimates that about 25% of total world exports is paid for in kind rather than cash (Walsh, 1983). The OECD conservatively estimates that coun tertrade accounts for 15% to 20% of East-West trade, but for less than 10% of trade among OECD countries (OECD, 1985). Even the most conservative estimates of Western trading houses put the countertrade figure at 10% of world exports. This means that exports worth at least 180 billion in OS dollars are being paid for by goods and services rather than in cash. A OS Department of Commerce study reports that 34 countries currently impose countertrade requirements. Less conservative estimates, using a broader definition of what constitutes countertrade, put the number of countries engag ing in countertrade at 88 (Welt, 1985). The consensus of most observers of countertrade, especially those in the business world, is that the list of countries engaging in countertrade is growing, as is the magnitude of countertrade mandates and the mechanisms used by national governments to encourage countertrade (Everett, 1977, 1985; Chesser, 1981; Pine,1984). Figure 2-1 reveals the pervasiveness of coun tertrade. We also note that countertrade is no longer an East-West or North-South practice because Western countries push countertrade also among themselves especially with re spect to trade in military goods (Welt, 1985). 12 2.3 The Main Forms of Countertrade Using OECD categorization (OECD, 1985), countertrade transactions can be divided into two main categories: com mercial compensation and industial compensation. a. Commercial compensation Commercial compensation refers to a countertrade deal where the compensation is in terms of goods that are not related to the original sale. They are generally one-shot operations for small or moderate amounts. The transactions are typically completed in 2 or 3 years. The main forms of this type of compensation are barter and counterpurchases. 1. Barter A barter transaction takes place under one or more simultaneous contracts specifying the goods to be exchanged by each party, at an approximately equivalent value. The contracts determine precisely the various conditions custom ary in trade, in particular volumes, prices, qualities and delivery times. This method is almost exclusively appli cable to the exchange of homogeneous goods which permits easy verification of both quality and volume and the use of international prices as in the case of agricultural and mineral products. The need for financial settlements of the exchanges is minimized by the virtual simultaneity of the flows and equivalence of the values traded. However, barter 13 must not necessarily be considered as trade without money, since, when shipment times are not simultaneous or a balance needs to be realized, currency transfers may be involved. At present, pure barter not involving the exchange of money is rare. Table 2-1 provides a sample of barter agreements in volving the exchange of agricultural commodities among LDCs. 2. Counterpurchase Counterpurchase is currently the most commonly used form of commercial compensation. It consists of the obliga tion, assumed by one party at the time of effecting a sale, to undertake or cause to be undertaken purchases of products which are generally not related to or derived from the prod- ? ucts sold. The purchases do not necessarily have to be made! from the same enterprise as that which bought the goods in question. Counterpurchase is conducted under two seperate con tracts linked by a protocol. This makes financing a coun terpurchase agreement similar to that of standard trade, since each of the agreements is an exchange of goods for hard currency. The separation of contracts also protects the original sale from encumbrances so that the payment for the sale cannot be legally withheld if problems arise in the execution of the second contract. 14 The counterpurchase agreement frequently leaves to separate contracts the determination of the specific details of each purchase. Each separate contract is practically autonomous, the different ones being related only to the extent that they contribute to the fulfilment of the origi nally assumed obligation. Frequently, however, there are limitations on the products eligible for the fulfilment of the obligation and occasionally there are also restrictions on the markets in which they may be sold. The essential difference between counterpurchase and barter is that in the latter form of agreement the products, qualities, conditions of delivery and values to be traded are stipulated precise ly, whereas in the case of counterpurchase, although the flow in one direction is defined in detail, the flx>w in the other direction is subject only to a general commitment, the specifics being spelled out in independent contracts (Ho— dara, 1984). b. Industrial Compensation Industrial compensation, on the other hand, involves the sale of technology, plant or equipment with a contractu al commitment on the part of the seller to purchase a cer tain quantity of products that are produced by or derived from the original sale. Because these transactions involve setting up entire production facilities, their values can 15 run into hundreds of millions of dollars. Also, the dura tion of the transaction is typically much longer and has been known to go as high as 25 years. Other names for the same transaction are "offset", "buyback" and others. Regardless of the name used, the com mitment to buy back goods as a proportion of the original sale is typically greater than in the case of counterpur chase, with counterdeliveries often totalling 100% or more of the value of the original sale. As in counterpurchase arrangements, buyback deals are conducted with two or more contracts. These arrangements gain additional importance, however, because of the value and innumerable variables in volved. Table 2-2 presents a sample of industrial compensa tion transactions in the field of chemicals taking place between 1975 and 1978. It is important to note that the data provided in table 2-2 is probably the only data avail able on industrial compensation in a specific field and over a period of several years. c. Military Offsets Compensatory transactions involving military trade and certain civil procurements, such as sales of commercial air craft are known as offsets. These arrangements usually com bine domestic content, coproduction and technology transfer requirements with long-term counterpurchase requirements. Governments play major rolles in negotiating or facilitating 16 most offset arrangements. The common roles played by a gov ernment in offset transactions are as a supplier or as an active negotiator or approver of export licences for copro duction arrangements. Although the military offsets could be assimilated so as to constitute a variant of the above-mentioned method of counterpurchase, we treat it separately because of its intrinsic importance (Hodara, 1984; Welt, 1985). Finally, although other forms of countertrade, like evidence accounts and framework agreements, can be encoun tered in the literature, these forms are not discussed here because of their similarity to the barter and counterpur chase agreements described above. 2.4 The Origin of Countertrade Countertrade, especially in the form of pure barter, is certainly the oldest form of international trade known to man. Long before international monetary systems were devel oped, commerce was conducted through trading that took many of the forms of countertrade now in use, including barter and counterpurchase. Countertrade, although not recognized as a specific form of trade at the time, has been used to conduct interna tional business when monetary systems break down under the pressures of war, extreme inflation, or other conditions that render trade in currency impractical or undesirable for 17 a national economy. The practice o£ countertrade first emerged on a large scale in this century after World War I. Germany used it during the Weimar Republic when its currency had become too unstable to be used as a medium for foreign exchange. The practice of countertrade helped nurse its war-ravaged economy back to health. Similarly, national economies of Europe reverted to barter and international clearing arrangements as a means of helping to recover from the devastation of World War II. In exchange for machinery components, for example, Germany was able to provide manu factured goods. France, in return, was able to use its large agricultural base to provide food stuffs in order to pay for technology and equipment which were needed in order to rebuild its manufacturing industries (Verzariu, 1985). 2.5 Economic Pressures for Countertrade Recently countertrade started to emerge on a large scale as opposed to its early sporadic use. To be able to understand why this is the case, we need to look at counter trade in an international context. If we divide the world into LDCs, EECs and DCs and look at what's happening in each one of these groups of countries, we see a simultaneity of conditions that when coupled with the interdependence of today's world nations fuels the use of countertrade. Starting in the mid 1960's the Soviet Dnion and other EECs adopted ambitious industrialized plans. As a result 18 their need for capital goods from the West surged. With the expansion of trade relations with the West during the period of detente in the early and mid-1970's, these plans held the promise of increased exports to the industrialized world. The failure of their export capacity to keep pace with their foreign expenditures, coupled with the general slump of trade in the West, resulted, however, in serious balance of trade problems for most EECs. By 1982, the combined hard currency trade deficit of the USSR and other EECs had reached an estimated $12 billion. With extremely lean cur rency reserves, EECs turned increasingly to foreign credit in order to finance their deficits. The result was a five-fold increase in the net external debt of the countries in the Council for Mutual Economic Assistance (CMEA) from approximately $12 billion in 1973 to $58.5 billion by the year-end 1978. By the end of 1981, CMEA net external debt reached $88 billion- an annual debt growth of 38% since 1973. Those conditions encouraged the use of countertrade (Verzariu, 1985; Welt, 1982, 1984a). The same economic pressures that led to the widespread practice of countertrade in EE are increasingly having the same effect in LDCs in general, and the largest such country the People's Republic of China in particular. For both non-oil LDCs in general and China in particular, the aspira tions toward industrial modernization are out of proportion to the ability to pay for it with hard currency. These 19 countries' only recourse is to pay for hard currency imports with earnings from domestic exports. The problem, however, is that when the economic climate in the industrialized countries worsens, there is an automatic ripple effect on the economies of LDCs, whereby their export markets and, subsequently, their foreign exchange earnings are substan tially reduced. Surely enough the (DCs) are staggering under the triple weight of budget deficits, high real interest rates and their gradual and uneven recovery from recession. Record OS trade deficits and a dollar that was badly overvalued prompted new protection for the American steel, textile, auto, sugar and other industries. In the case of Japan despite huge trade surpluses and low unemplyment, it barely accelerated the liberalization of its amply protected econo my. Slow recovery in Europe left unemployment at high lev els further reinforcing European resistance to foreign com petition. As trade friction, sectoral trade restrictions and protectionistic pressures have intensified worldwide, DCs are increasingly treating international commerce as an extension of national economic policies and are dealing with problems of trade competition through bilateral accomoda tions. For instance, French and German banks demand that any new loans to Brazil be tied to their exports to Brazil. It is this unbalance in the world economy, coupled with general protectionism, the fact that DCs need the markets 20 as well as the resources and raw materials available in the LDCs and EECs, and that the latter group of countries need the technology and also the markets of the former group, that fuel the continuing use of countertrade. Finally, there seems to be an agreement among all coun tertrade analysts on the permanent nature of countertrade (Verzariu, 1985; Welt, 1982; Welt, 1984a). Countertrade will continue to play an important role in world trade as long as the above described conditions continue to exist and these form a sort of a vicious circle that makes counter trade last, especially when considering its wide geographic expansion that we describe below. There is considerable disagreement, however, on its expected magnitude as a per centage of world trade. Estimates vary between 15 and 50% of world trade by the year 2000. Several sources agree, however, that countertrade's place in economic history will be determined not by its size but by its ultimate effect on world trade most of which is still unknown because this method is still new (Elderkin and Norquist, 1987). 2.6 Countertrade Practices in Various Regions of the World LDCs and EECs encourage and mandate countertrade in order to reduce their trade imbalances, foster the exports of certain industries targeted for growth, upgrade certain individual sectors tthrough foreign investment, and safeguard their hard currency reserves. Western countries and compa 21 nies seem to accept countertrade demands in order to achieve sales that would be otherwise impossible and to gain prominence in new markets, thereby enhancing the prospects for future sales (Welt, 1982). In the case of the industri alized countries imposing countertrade requirements, trade imbalances and hard currency reserves are not the issue. Rather, countertrade is demanded in these cases because of (a) the buyer's leverage over individual supplies in indus tries in which supply exceeds demand, (b) the procurement is large and (c) there are a number of companies bidding for the contract (Welt, 1985). While each group of countries described above imposes countertrade for the same basic rea sons, different countries use this unconventional method of trade in differing degrees and different ways, a. East Asia and the Indian Subcontinent All major countries in East Asia are active users of countertrade. Japan is believed to be the heaviest user of countertrade in the region followed by China and Indonesia ranking third. The competition among various countries was the major factor responsible for the growth of countertrade in this region during the last four years. For instance, the Malaysians enacted their countertrade laws in part out of fear that Indonesia, with its mandated countertrade laws, would take over portions of their rubber, tin and oil mar kets. In the Indian subcontinent, the level of countertrade 22 activity is low by comparison to the rest of the world. However, it is increasing at a fast rate especially in India following its economic reforms. Burma, Bangladesh and Sri Lanka are dabbling in countertrade, for the most part on a case-by-case basis and with their usual trading partners. Pakistan seeks to countertrade more and more, but like South Korea, Malaysia and Singapore, finds itself caught in a debate over countertrade's long-term merits (Elderkin and Norquist, 1987). b. Europe EECs are the oldest and most frequent users of counter trade. As far back as the mid 1960's, they used counter trade techniques to finance technology imports. From this early sporadic use, by 1981 countertrade had increased to account for 30% of EEC trade and has been climbing eversince (Business International Institute, 1981). According to au thorities on countertrade in EECs, half the countertrade done between this region and the West is in the form of industrial compensation. The USSR does more countertrade than any other nation in the world (OECD, 1981). Like the US, most West European countries do not like to countertrade, but engage in it when they feel it is in their interest to do so. Several of them do more counter trade than the US because they are more internationally oriented and have colonial ties and a greater need to buy 23 resources. Austria, France, Italy and the Onited Kingdom probably are the most active countertrading countries in Western Europe (Elderkin and Norquist, 1987). c. Africa and the Middle East Countertrade in the Middle East and North Africa typi cally involves countertrade of oil. Prior to the recent drop in oil prices, as much as $30 billion worth of oil was being countertraded by OPEC. A number of countries such as Iraq, Kuwait, Libya, Algeria, Qatar and Iran use oil to pay for their imports. In the past countertrade in oil provided a method of circumventing OPEC pricing. But with the abandonment of the OPEC quotas in late 1985, oil countertrade now provides a means of increasing market shares. Libya and Kuwait have traded technology, for example in the form of the installa tion of refineries, for paybacks in refined products. Saudi Arabia has made several huge countertrade deals involving military hardware. Iraq has used oil to help pay for its oil pipeline through Saudi Arabia (Elderkin and Norquist, 1987). Africa has only recently started to use countertrade. It refrained in the past largely because of lack of govern ment coordination, IMF pressure not to get involved in coun tertrade, some bad experience with the EECs and fear that countertrade would diminish its foreign exchange earnings. However, because of its rapidly rising shortage of foreign 24 exchange and its wealth of raw materialsr Africa is expected to engage more extensively in countertrade in the future than in the past (Business International, 1984). d. Central America, South America and the Caribbean Most Caribbean countries do not have large enough mar kets or enough available goods to make countertrade worthwh ile. In Mexico, however, which has the largest GDP and external debt, countertrade activity has grown rapidly in the last five years and is expected to continue to do so. The countries of Central America all do some countertrade, but, because of the political and military turmoil in the region, countertrade is practiced only to a limited extent. Most of the countries in South America are heavily indebted and in desparate need for foreign exchange. They use countertrade to increase their exports and strenghthen their private sector. Brazil is by far the heaviest coun tertrader on the continent, with Colombia coming in second only because of its smaller size. Colombia has the most aggressive countertrade law outside of the EECs and Indone sia (Elderkin and Norquist, 1987). e. North America Countertrade accounts for about 9% of the total value of international trade in the U.S.. For some industries, however, the percentage is much higher. For instance, in aerospace countertrade is estimated to account for nearly 50% of the transactions; for construction projects it is 25 27%; and for electronics it is 20%. A recent survey con ducted by the National Foreign Trade Council Foundation re veals that the need for countertrade in selling US exports has increased dramatically over the last five years. For the years 1981 and 1982 alone, for example, the number of reported countertrade transactions grew by 64% and 117%, respectively. The survey also points out that the inability or un willingness of some companies to get involved with counter trade is leading to more than a 5% loss of US exports. The point that most studies on the US stress is that, whether US companies like it or not, exporters will face more counter trade in the future. There is also a distinct possibility that, if US firms are not willing to.participate in counter trade, they will be further displaced in the world market, even by less competitive firms, who are more willing to undertake countertrade (Vardiabassis, 1985). Finally, the exact size of Canada's countertrade activ ity is not known. What is known, however, is that it fre quently gets involved in barter trade deals. Canada is also known to request offsets in all its arms deals, most of which are with the US (Welt, 1984a; Verzariu, 1985). 26 Figure 2-t. Countries Involved in Countertrade. E m Germany Czechoslovakia PoUnd Romania U.S.S.R Sweden Norway Canada Denmark Netherlands Austria United Kingdom Belgium France Jamaica Portu«#l Spain South Korea Peoples Republic ® of China 0 Bulgaria Hungary Italy Switzerland Yugoslavia Turkey Egypt Australia Uruguay Zealand Indonesia Philippines to *0 Source: (Welt, 1985) p.4 Table 2~1» Barter of Agricultural Commodities Between LDCe. Countries Commodities Exported A B ilZuO Frame A B Remarks Ethiopia Algena 3-yr annual renewal Cotlee. hides and skins, oilseeds, spices, and other agricultural prod ucts Industrial products No specitic quantity given First trade agreem ent between these two countries Signed at ministerial level Venezuela Argentina 1976 150.000 ml iron ore 20,000 mt wheat; 100.000 ml grain, sorghum, or corn Prices to be established prior to each monthly shipment Argentina will pay lor the rest in cash Shipments were delayed due to logistics problems Peru Argentina 1976-78 ^Copper, iron ore. cotton Wheat, corn. beet, otlal Value equalled U S. SI50 million Peru Hungary 1977-80 Fishmeal; cotton, cotlee. minerals Wheat, equipment Value equals U S . $40 million Peru Brazil 1977-80 Minerals, iishmeal Soybeans Democratic Republic ol Germany Brazil 1981-83 Soybeans and products Coal, potash Value on each side equals US. SI00 million Mexico U .S.S.R Started Jan. 1981 with no time limit Cotlee, cocoa, lettuce Petroleum extracting equipment, textile indus trial equipment, agricul tural tractors This agreem ent may be a trian gle trade pact with agricultural commodities going to Cuba and the U S S R, sending the equip ment to Spain and. in the end. swapping customers. N> <de Marinis, 1382) p.44 09 Table 2-2. Western Chemical Compensation Agreements With East ern Europe and the Soviet Union. Western Company Year Contract Signed Eastern Country Equipment Supplied Total Value oi Eastern Export (in million S) Planned Yearly Value of Exports (in million $) Time Span of Buyback Deliveries Occidental Petroleum (U S ) 1978 Poland • Phosphate rock 670 335 1978-1997 Rhone Poulenc/lnstilule Fran cois du Petrole (France) 1975 Poland Chemicals and textile fibers NA NA NA Ugine Kuhlmann (France) 1976 Poland Unspecitied cooperation in chemical production NA NA NA Uhde/Hoechst (West Germany) 1976 East Germany Complex of 4 plants in cluding 1 for producing caustici soda 32 4 1980-1987 Catalytic (United Kingdom) 1977 East Germany Chlorine plant 115 23 NA Petrocarbon Developments (United Kingdom) 1975 Poland Chlorine plant (part of larger deal) NA NA 1980-1989 Krebs/Klockner (France and West Germany) 1975 Poland Soda ash plant 180 30 1980-1985 De Nora (Italy) 1978 Romania 2 chlorine plants NA NA NA Chemie Linz (Austria) 1976 East Germany Pesticides, herbicide agents gnd fertilizers 58.58 NA NA Vereinigle Edelslahlwerke (Austria) 1977 East Germany Fine steel products NA NA NA Haldor Topsoe (Denmark) 1978 Bulgaria Ammonia plant 7 1 1978-1984 to us 8outuc: (Vogt o* - ’I, 1982) CHAPTER 3 OFFICIAL ATTITUDES TO COUNTERTRADE: BETWEEN ACCEPTANCE AND DENIAL According to GATT, countertrade is a sin to be guarded against. The official reason for this is that countertrade, is a return to barter and, as a result, it operates against free trade, against liquidity and against the use of curren cy as a means of exchange (Assaad, 1984). While this was the official attitude of all Western and North American governments, the proliferation of countertrade in interna tional trade has created a dilemma for them. On the one hand, they cannot officially support a "primitive" mode of trade, and on the other hand, they cannot prevent the expan sion of their own foreign trade by banning it. Also, they cannot leave the private sector exporters, involved in coun tertrade, without any guidance or assistance. The result is a contradictory position for which evidence can be found in each one of these countries. International organizations like the OECD, IMF, and GATT do not seem to have reached a clear cut position towards countetrade either. While their published reports always describe countertrade as "bad busi ness" none of them has even come close to actually making it illegal for their members to conduct. The purpose of this chapter is to provide evidence for the situation described above and explain its implications. 30 Sections 3.1 and 3.2 discuss the attitudes of the DS govern ment and West European governments respectively. Section 3.3 concentrates on the special case of military offsets and section 3.4 focuses on the indecisive position of the OECD, IMF and GATT. 3.1 The PS Government Attitude The DS government attitude is a case in point, as a result of its long-standing policy objectives of multilater alism and free trade, the OS has taken a strong position against countertrade at least officially. However, its pri vate or unofficial attitude has, over time, drifted more and more away from its official one. Private attitudes refer to its locally involved policies as opposed to its official statements made in GATT and other international fora. The deviation of private from public policy on the part of the OS government started with very limited government assis tance to DS exporters invovled in countertrade. Then, on a few occasions, the DS government's export credit agency, the Export-Import Bank extended credit to exports involving countertrade. Later the Commerce Department evolved a poli cy that contradictorily synthesizes pro and con positions. On the one hand, countertrade has been described as "bad business" that "contravenes our commitment to an open inter national trade and monetary system" by Lionel Olmer, Onder- secretary of Commerce for International Trade. On the other 31 hand, the Commerce Department has begun to assist exporters in facing countertrade demands, by providing advice on nego tiating tactics, market information and how to sell the countertraded goods in the DS (Welt, 1984a). The role of the DS government was not just an advisory one, however, as it has actually engaged in various forms of barter deals. An example of such activity would be that of the Department of Agriculture which, through the Commodity Credit Corporation (CCC), has actually engaged in almost $2 billion of barter of strategic materials obtained from other countries in exchange for OS agricultural products. Those deals occured between 1950 and 1973. The practice was sup posedly suspended in 1973, but due to a stockpiling of agri cultural products, the pressure is growing again for some kind of barter arrangements for strategic materials. In fact, in the Export Administration Act (EAA) which primarily deals with foreign policy and national security controls, there is a provision entitled "Materials in Short Supply" that specifically discusses barter arrangements in one of its amendments. The provision specifies that the secretary of agriculture submit to Congress a report that would include any necessary changes in the existing laws to allow the Department of Agriculture to fully implement any barter programs. We also note that recently the DS worked out an agreement with Jamaica for bauxite in exchange for dried dairy milk (Korth, 1987). 32 In 1982, the government signed into law the ETC (Export Trading Company) legislation. An ETC is a company doing business in the DS, principally to export goods or services produced in the DS, or to facilitate such exports by unaf filiated persons. It can be owned by foreigners and can import, barter and arrange sales between third countries, as well as export. The purpose of introducing ETC was to stim ulate export initiatives by liberalising restrictions on investments by banks in export trading companies and by allowing exemption from antitrust laws for the export trad ing company’s member firms. Although specifically intended to foster OS exports in general, the act's antitrust provi sion could facilitate the handling of countertrade obliga tions by member countries. More important, however, the ETC act came to break the barrier between banking and commerce thus allowing banks to get more deeply involved in counter trade. The act was adopted after three years of rough legisla tive battling and a lot of pressure from banks who witnessed the proliferation of countertade and wanted to exploit the available possibilities of profit. By 1984 at least 35 new trading firms have been created and more are being estab lished. Citibank, Bank of America, Security Pacific Bank and First Chicago Bank are some of the banks involved in countertrade. Some of these banks have even attempted to launch new concepts aimed at multilateralizing countertrade 33 obligations. Whether these schemes will be accepted by the different countries involved or not is not the concern of this study, the point to stress is that banks are highly involved in countertrade and have managed to put pressure on the government to get even more involved. We finally note that an information and market intelligence service of US firms involved in countertrade is being set up through the Domestic and Foreign Commercial Service (DFCS) (Welt, 1985). We finally note that the change in the unoffical atti tude of the OS government has also been influenced by pres sures from the private sector which is not surprising if we look at some of the names involved in countertrade: General Motors, McDonnel Douglas, Sears World Trade, Control Data Corporation (CDC) among others. Some of these huge compa nies have even set up their own trading units, instead of relying on the services of separate trading houses, due to their heavy involvment in countertrade. 3.2 The Attitudes of European Governments Similar to the DS, all West European nations officially discourage trade outside of the GATT multilateral system, and disapprove of government-mandated countertrade. Howev er, in order to meet the demand of private industry and in order to remain competitive with Japan and other countries more knowledgeable in countertrade, several countries have established mechanisms to disseminate information and to 34 assist £irms confronted with countertrade requirements. Assistance related to countertrade provided by public or private entities in Western Europe varies from the advi sory services provided by the UK Export Policy Branch of the Department of Trade and by national trade associations in West Germany and Belgium to the commercial type companies such as Finland's Metex which represents private and public sector engineering firms and handles the countertrade trans actions of its member's and other firms. In Austria, the Liaison office of Foreign Trade (Evi- denzburo) originally created in 1968 as a nonprofit organi zation to promote the East-West trade of the members, is increasingly becoming engaged in countertrade. The French service for countertrade was formed in late 1977 with the support of the Ministry of Foreign Trade. It formed a group known as ACECO ( Association pour la Compensation des Echange Commerciaux) made up of bankers, industrialists and govrnment officials to advise French companies on how to handle compensation deals. ACECO also tries to screen out the deals that might be harmful to the French market (Verzariu, 1985). So far we've been talking about the help provided by the Western governments for their exporters involved in countertrade deals in a general way. The next section deals 35 with a particular type of countertrade, military offsets, in which the contradiction in the public and private attitudes of governments is even more pronounced. 3.3 The Case for Military Offsets The West European attitude towards countertrade does not parallel their attitude towards military offsets. In fact, some countries market offset arrangements for the na tions procurement, other countries solicit offsets for their own procurements. Regarding the former, both West Germany and France "sell" offsets to make their military equipment more attractive to potential buyers. Regarding the latter, the countries that solicit offset arrangements for military purchases most are: Austria, Greece, Portugal and Spain. Portugal, for instance, usually requests 20%-30% offsets and has a memorandum of understanding with the OS mutually agreeing to the inclusion of offset arrangements in military procurement from the OS (Welt, 1984a; 1985). The same applies to North American countries, while officially frowning on countertrade, these countries contin ue to stimulate large scale trade agreements with offset contingencies, especially military. Canada is in fact one of the world's leading purchasers of military offset pro curements, and typically requests offsets from 90% to over 100%. As Canada's number one trading partner, the US is the primary supplier for these contracts, along with others in 36 Western Europe, the Middle East and Australia. In fact, the US has not only accepted countertrade demands but has actu ally promoted countertrade. During the last two decades the US government policies have encouraged the provision of large amounts of technology and production know-how to NATO allies as an inducement to purchase US weapons. It has been estimated that during the next five years, this kind of offset arrangement will amount to $6 billion a year (Korth, 1987). From the evidence presented above, it is easy to con clude that the contradictory attitudes of Western govern ments are the outcome of a political problem rather than an economic one. Each one of these countries is trying to set a high standard by refusing to accept anything other than free trade; at the same time, however, it doesn't want to jeopardize its interests by not using countertrade. As a result, each country portrays a public image that belies private practice. The same applies for the attitudes of the OECD, GATT and IMF that are discussed below. 3.4 The GATT, OECD and IMF Going back to the quotation, at the beginning of this study, describing countertrade as a return to archaic forms of business and a disease that should be stopped from spreading, an obvious question arises. If countertrade is so bad, why is it not banned? According to GATT officials. 37 since no member country has ever raised an official protest against these restrictive practices no action has been taken. The reason why this is the case, GATT officials add, is the fact that all governments accept that some forms of trade balancing as being necessary mostly because of the economic conditions described in chapter 2 above. Counter trade helps to keep exports flowing in a period of economic recession. GATT officials emphasize that " at a time when creeping bilateralism is a fact of life not only in trade with BECs and LDCs but even in trade among DCs, countertrade will be tolerated and no action against such practices can be expected" (Business International, 1983) p.233. Similarly, there seems to be a split in the position of OECD members. Following three years of regular meetings and much give and take among its members, the OECD trade commit tee has, in 1985, finally approved a policy paper on East-West trade. The split in the OECD resulted in a paper that does not ban countertrade but merely conveys a message that " a member nation's exporters can countertade with EECs when necessary and appropriate but should be made aware by their governments of some of the more objectionable aspects of the practice". The paper presented some of the problems associated with those deals, but did not provide any reme dies or solutions (Countertrade Outlook, 1986). As for the IMF, the Fund generally disapproves of coun tertrade. The IMF's 1983 Annual Report on Exchange Arrange— 38 ments and Exchange Restrictions says: "The fund is generally concerned with their proliferation because they may be seen as undermining the objective of the multilateral trading system, the promotion of which was a basic objective for the setting up of the fund, and also because they share many of the microeconomic disadvantages that are common in bilateral payment arrangements . "The Fund's policy on counter trade practices is to encourage its members to rely on ap propriate fiscal, monetary and exchange rate policies rather than on restrictive practices to achieve balance of payments adjustments” (Business International, 1984a) pp.20-21. Ironically, however, the austerity programs that the IMF imposes upon the LDCs often cause these countries to resort to countertrade. The call is always for lower im ports and larger exports. Since LDCs have few other alter natives besides countertrade to achieve that target, the measures imposed by the IMF will probably lead to counter trade. The attitude of the official bodies towards contertrade raises an additional question, if countertrade cannot be banned because it has become such a fact of life, why isn't any attempt made to standardize the rules governing the commitment of the parties involved, knowing that this would reduce the "evil" caused by countertrade if there is any?. Acccording to trade lawyers specializing in countertrade, there is no legal regime and no set of rules, applying 39 specifically to countertrade transactions involving private companies nor to offset arrangements for government purchas es of military hardware. Consequently, companies are forced to comply with a host of national laws, regulations and policies of the governments of their home countries, host countries, trading partners and any third countries to which they export countertrade goods which leads to a lot of con fusion and inflexibility (Assaad, 1984; Zarin, 1984). It then follows from the above description that the public rejection of countertrade on the part of Western governments and various international organizations due to unnecessary rigidity in what regards the economic assump tions and principles developed over the past millenia, have led to chaos in the countertrade market. There is no offi cial recognition of countertrade transactions, and no stan dardized rules or regulations to govern the commitment of the parties involved. Had countertrade been officially ac cepted, however, it wouldn't have meant the abolition of free trade but rather a chance to seriously study an alter native that might be useful especially given the shaky worldwide financial situation and the uncertainties in volved. 40 CHAPTER 4 EGYPTIAN CASE STUDY The purpose of this chapter is to study the Egyptian experience with countertrade. Romania is the other case study to follow. Unfortunately, since the available information is likely to vary in both quality and quantity from one country to another, it would seem dubious that a common method of analysis can be established. The chapter is organized as follows: section 4.1 attempts to answer the question of why Egypt got involved in countertrade transactions in the first place and seeks to identify any official directives stipulating how countertrade transactions are to be handled. In section 4.2, barter, the most common form of countertrade in Egypt, is discussed. Most agreements signed by Egypt in the period 1985-1987 are included. The actual contract for one of these agreements is given in appendix A. The difference between these barter agreements and the old bilateral clearing agreements that were fashionable in the 50's and 60's is also discussed in the same section. Section 4.3 is confined to two very specific counterpurchase agreements in which Egypt has become involved: the General Motors (GM) project (proposed in 1985) and the tourism project proposed 41 by the Japanese company (NEC) in 1986. The actual proposal in the latter case is included in appendix B. Finally, a general evaluation of the Egyptian experience with countertrade and a look at its future there are the subjects of section 4.4. 4.1 Whv and How Egypt Uses Countertrade 4.1.1 The Economic Atmosphere that Encouraged Countertrade in Egypt Beginning in the early 1980's, Egypt started to closely monitor the experience with the various unconven tional trade practices that can be aggregated under the general title of countertrade. Impressed by the experience of some EECs already involved in these trade practices, like Yugoslavia, Egypt began to look at countertrade as a method for improving its balance of trade and preserving its hard currency. The importance of those last two targets for Egypt at the present time cannot be overemphasized for the following reasons: First, due to its large population and ambitious development plans, Egypt's consumption and investment • imports are substantial; in 1985 the total value of Egyptian imports was estimated to be almost 40% of its GNP. Second, while Egyptian imports have been increasing at 42 unprecedentedly high rates, exports have been increasing only very slowly. The result has been an ever-increasing trade imbalance and a decreasing export-import ratio (table 4-1). Third, the deterioration of the balance of trade in Egypt is accentuated by the fact that for a very long time Egypt has been relying on one, and one only, main product for export. While it used to be cotton, beginning in the mid 1970's it has become oil. In the early 1980's oil exports constituted around 70% of Egyptian total exports. Reliance on oil exports, however, meant that Egypt was extremely vulnerable to changes in oil prices. Indeed, the drastic fall in the price of oil in the early 1980's caused the country's monthly income from oil exports to suddenly drop from $205 million in 1981 to only $145 million in 1985. At the same time, since the local consumption of oil has also been increasing rapidly smaller and smaller amounts of oil have been available for export. Fourth and last, as a result of the rapidly accumulating foreign debt and debt service, which has to be paid for in hard currency, a large portion of the hard currency returns from exports have had to be allocated to the repayment of debt, 1/5 in the period 1972-1981, which has implied an increasingly limited ability to import Egypt's basic needs (Report on the National Conference for Exports, 1985). While detailed analysis of Egypt's trade imbalance and 43 debt problems is beyond the scope of the present study, it is these problems which have encouraged Egypt to get involved in countertrade. The linking of import and export transactions that is the essence of countertrade was deemed capable not only of improving Egypt's balance of trade by guaranteeing that Egyptian exports would increase along with its imports but also of helping Egypt preserve hard currency by making sure the expenditure of hard currency for foreign imports is offset by hard currency earnings generated by the foreign party's obligation to purchase domestic goods. 4.1.2 The Formalization and Regulation of Countertrade At the present time there is no pronounced law imposing countertrade demands as a precondition for any particular trade deal or industrial project to be approved by the government. However, there is a clear understanding among officials in the Egyptian government and the public sector hierarchy that countertrade is to be encouraged whenever possible. According to the Minister of Industry, this attitude of encouraging countertrade when not decreeing a law to specify any exact countertrade demands from foreign partners was chosen by Egypt for two main reasons: first, to guarantee flexibility in studying and analyzing countertrade transactions on a case-by-case 44 basis, thereby choosing what is best for Egypt. Second, it gives Egypt the opportunity to learn more about the mechanics of countertrade since it is a newcomer to this particular form of unconventional trade and is therefore inexperienced. Finally, negotiations for countertrade transactions in Egypt are not handled by various ministries as in the case of regular trade deals. Instead, there is a governmental committee formed specifically to negotiate, evaluate and decide upon various countertrade proposals especially the ones involving barter. 4.2 Barter Agreements 4.2.1 Today's Barter Agreements versus the Old Bilateral Clearing Agreements As mentioned above, barter is the most common form of countertrade in Egypt. One can't help but ask, however, if what Egypt is involved in today is nothing but barter, then what is new? How different is today's barter from old time barter with the EECs that was fashionable in the 50's, 60's and early 70's and often called bilateral clearing agreements? Before attempting to answer this question, however, it is first important to clarify that when discussing old or new barter, one never means the extinct 45 form of pure barter where the exchange of an equally valued specific amount of goods takes place here and now. Today's countertrade in the form of barter and the old bilateral clearing agreements are two different forms of agreement that have a common barter feature and that is the avoidance of payment in international currencies. At the same time, however, they are much more flexible than pure barter. In answering the question above, a summary of the major deficiencies of the old bilateral system as experienced by Egypt is first presented. A description of how different today's barter is from the old bilateral system, as provided by the Egyptian officials, then follows. In the latter subsection reference is made to several articles form the 1987 barter agreement signed between Egypt and Yugoslavia (Appendix A). a. The Old Bilateral Clearing Agreements Bilateral clearing agreements experienced by Egypt were agreements between the governments of two countries that wish to trade with one another without expending foreign currency. Under this arrangement, each one of the two governments agrees to import a set volume of goods from the other over a specified period of time. The agreements were very general and loose in nature and the lists of goods provided on both sides were simply lists of available 46 goods not reflecting what is really needed by both countries. Moreover, the agreements did not hold any specific company or organization, on either side, respnsible for the execution of the contracts which led to confusions and frequent delays. Another major disadvantage of bilateral clearing agreements, as experienced by Egypt, has to do with the accounting system used. In this type of agreement, the bilateral balance of trade was monitored by keeping accounts in artificial units bearing the denomination of one currency or another: clearing dollar, swiss franc and so on. The problem with this method of accounting, however, was that the artificial units used were never realistic. They did not reflect the true free market exchange rates between the local and international currencies but rather depended on the negotiating skills of both parties signing the contract. The same problem applied to the prices of the goods exchanged as they never reflected the international market prices. Furthermore, the equality of the values exchanged was never really achieved. Finally, under bilateral clearing agreements, Egypt, as well as several other LDCs, repeatedly experienced the situation in which commodities which they had exported under bilateral agreements to EECs, especially the USSR, 47 were re-exported and dumped on the world market (OECD, 1979b). To avoid this problem they often insisted on adding to the contract a specific clause concerning re-exports, wherein re-exports of commodities exported by one contracting country to the other were either prohibited or, in rare cases, allowed with the consent of the original exporting country. b. Today's Barter Agreements While similar to older bilateral clearing agreements in the sense that two parties from two different countries agree to exchange equally valued amounts of goods over a specified period of time, it is argued by governemnt officials that today's barter agreements or countertrade agreements are different in several respects. First, the agreement is signed by two specific companies in the two countries. The companies are equally responsible for the execution of the contract on time. This arrangement helps avoid the confusion encountered with bilateral clearing agreements as explained above. Second, any imbalance that appears in the account by the end of the period of the contract is settled within a short specific period of time to avoid any accumulation of debt (appendix A- article 6). Third, the lists of goods exchanged are specifically included in the contract and any changes in their kind, 48 quantity or value can only be done by written approval of both contracting parties (article 2). According to Egyptian officials, unlike bilateral clearing agreements, the goods exchanged under today's barter agreements are more specifically identified and do reflect the needs of the two contracting parties at this particular time which reinforces the purpose of trading. Fourth, the prices of the goods exchange are specified in US dollars and according to the international prices prevailing on the world market for such products (article 3-b). Fifth, the payments relating to the fulfillment of the agreements are arranged via special banking agreements that have as their main feature the specification of accounts in free US dollars (article 5). In other words, while hard currency may never be exchanged, there are no distortons in the accounting system. 4.2.2 Barter Agreements Signed in (1985— 1987) Detailed information on most of the barter agreements, or simply countertrade agreements as they are called in Egypt, that were signed in 1985-1987, (tables 4-2 and 4-3), was obtained by the author through various Egyptian officials interviewed. The agreements are not restricted to Arab countries and EECs. In fact, the majority of 49 agreements signed in 1987 involve Western European countries namely: Austria, Holland and most recently in August 1987 Sweden and Western Germany. The involvement of Western countries in barter agreements with Egypt pinpoints another difference between these agreements and the old bilateral clearing agreements in as much as Western countries had never gotten involved in the latter. It also implies that the goods exchanged are of adequate quality unlike the case of the old bilateral system where quality didn't matter and was typically poor. In the case of Barter agreements, the quality of the goods is one of the major issues in the negotiations. Although it is not explicitly mentioned in the general barter agreements, such as the one in the appendix, quality specifications are typically stated in the various exchange contracts that follow from it. From tables (4-2 and 4-3), it is noted that the products that are most needed by Egypt and that it attempts to obtain through its various barter agreements are: wood, cement, paper, leather, construction materials, chemicals and different forms of machinery. The Egyptian exports are of two types: traditional exports such as cotton, cotton yarn, aluminium products and nontraditional products like fruits, vegetables, ready-made clothes, perfumes, canned foods, shoes, furniture and others. Egypt has no problem 50 exporting its traditional products for hard currency. It is mostly its nontraditional exports that it seeks to promote through countertrade and this causes a certain complication in the negotiations for these agreements. According to the Egyptian officials interviewed, the other contracting party often seeks to get more traditional Egyptian exports than Egypt would want. Consequently, Egypt tends to specify that its traditional exports would not exceed 20% of the total value of the transaction as a precondition for negotiating the proposed contract. Another difficulty in the negotiation and execution of these agreements has to do with the exchange rate policy that prevails in Egypt. Until very recently, as in most LDCs, the Egyptian pound has been considerably overvalued. Using the official exchange rate ($1= 1.35 EP) in signing the agreements meant that the exported Egyptian goods would be very expensive for the foreign partner when taking into consideration the free market exchange rate ($1= 2.00 EP). Consequently, a special exchange rate had to be used for these barter agreements and this required government approval for each individual deal which meant rather long and complicated negotiations. Early in 1987, however^ the official exchange rate was changed to ( $1= 1.9 EP) and this is expected to reduce negotiation difficulties. A final source of problems for the negotiation and 51 execution of these barter agreements, according to Egyptian officials, is the difference between the international and domestic prices of goods. With domestic prices sometimes higher than their international counterpart, local producers tend to decline selling their goods through barter deals when they can get more profit in the domestic market even after the agreements have been signed and the quantities of goods specified. In that case more negotiations have to take place to agree on changes in goods exchanged. Comments The above described barter agreements have certainly given Egypt a chance to import some of its basic needs as well as export several of its non-traditional products more efficiently than under the old bilateral agreeements and without putting pressure on the government budget. It is important to note, however, that the details of the exchange contracts that follow from the general barter agreements, such as the actual prices of the products exchanged, are not available which renders an adequate evaluation of these barter agreements rather difficult. The difficulties encountered in the negotiations of these barter agreements as described by the Egyptian officials would seem to indicate, however, that Egypt is 52 likely to face, at a certain point, the risk of losing some of its traditional markets where it successfully sells its traditional exports for hard currency. This can happen in two ways: 1) re-exports on the part of its trade partners, as used to be the case under the older bilateral agreements; 2) if Egypt involves more of its traditional exports in these barter agreements. The lack of a clause prohibiting re-exports in Egypt's barter agreements could indicate that the problem does not arise, but it is still an impotant issue to address for Egypt to achieve the maximum benefits possible under these barter agreements. The same concern applies to the inclusion of products such as cotton, cotton yarn and aluminum to the list of products to be exchanged via countertrade. As indicated above by Egyptian officials, to date Egypt insists on a specific small percentage of these cash products to be exported through barter deals, the question, however, is whether this attitude will continue as the use of barter becomes more generalized and as more countries get involved. Requests for cash products could increase and become a precondition for the agreements to be signed. One last point to mention is that negotiating problems caused by the old Egyptian exchange rate policies and the current 53 inflation problems would seem to indicate that countertrade can be exploited to the fullest, only if Egypt's other economic problems are also solved. 4.3 Counterpurchase Agreements 4.3.1 The NEC Tourism Proi ect in Egypt a. The Main Features of the Proi ect The exact details of the proposal are provided in Appendix B. Only the main features of the project are summarized here. 1. The Japanese company NEC is proposing to promote Japanese tourism in Egypt and is providing all the necessary details for a tourism plan for one full year to be extended to several others. 2. The condition for this promotion of tourism to take place is that its hard currency return would exclusively go to the Arab Company for Transistor Radio and Electronic Equipment (ACTREE). 3. ACTREE, which is currently producing NEC TVs in Egypt using Japanese components, is expected to assign the returns from tourism to buying Japanese components for the production of TVs. 54 b. Benefits to NEC From Proi ect Egypt provides a market for the Japanese components. At the same time, NEC is aware that buying components with hard currency may not be possible for Egypt due to its economic problems. In fact, even though the original agreement for TV production was signed several years before, imports of components have been hindered by the lack of hard currency. By making the above-explained offer, NEC not only guarantees the sale of its originally agreed upon sale of components for TV production but more future sales as well. Moreover, by showing understanding for Egypt's economic problems, NEC also achieves a good rapport with the Egyptian government that could help boost future business. c. Benefits to Egypt from Proi ect The benefits of the proposed project to Egypt are several: first, the proposed project relieves the Egyptian government from the burden of providing hard currency for the importation of components for the production of NEC TVs. Second, it allows for an even larger production of TVs which would mean more sales both locally and internationally. Third, the promotion of tourism to be achieved by the project is in itself one of the priority targets of the Egyptian government at the present time. 55 d. Comments The interesting thing about the NEC project is its novelty. It is a countertrade agreement where the linking of the two transactions is clear. NEC promotes tourism in Egypt only if Egypt buys its components. The novelty, however, is in the nature of the goods involved. Tourism is treated as a tradable commodity that is indirectly exchanged for components needed for TV production. It is also interesting in the sense that it illustrates what countertrade is capable of achieving for LDCs. The important question to follow, however, is what is the price of all those benefits to Egypt? It is true that NEC ahcieves substantial benefits, but will that be enough or will NEC attempt to raise the price of the components so as it covers the additional costs relating to the promotion of the Japanese tourism in Egypt. One final concern has to do with keeping track of the Japanese tourists in Egypt and which of them are linked to the NEC project and which are not. 4.3.2 The General Motors (GM) Proi ect in Egypt Nasr Automotive manufacturing company (NASCO), the sole producer of passenger cars in Egypt, has issued an international tender for the production of small and mid-sized cars within its facilities. Through its 56 subsidiary in Germany, GM responded to the tender and proposed a self-financing project that was most appealing to the Egyptian government. a. The main Features of the GM Proposal 1. Create a joint venture to be responsible for the execution of the project. The joint venture would be called General Misr Car Company (GMCC) and would involve the following partners: GM 30%, NASCO 3 0%, Misr Iran Development Bank 3 0% and the Egyptian Bank for Export Development 10%. 2. Arrange for the production facilities in the following manner: a) All facilities at NASCO and American Arab Vehicles (AAV), will be allocated to this project. The former company has been introduced above. The latter is a joint company between the Arab Organization for Industrialization (AOI) and the American Motors company. It is specialized in the production of jeeps and wagons for military purposes and is also equipped to produce civilian vehicles. The use of both facilities (NASCO's and AAV's) is expected to cut considerably on initial investment costs. At this level the relationship between GMCC oh one hand and NASCO and AAV on the other hand will be one of subcontracting, b) Components needed for production and that can be manufactured in Egypt will be obtained via 57 another 24 component-producing joint ventures. The foreign partners in these joint ventures will be the same producers that GM deals with for production it its own facilities. The components that cannot be manufactured locally, estimated to be around 35% of the car by the time the project reaches its maturity stage, will be permanetly imported from GM. 3. At the beginning of the execution of the project, several components, beyond the 35% of the car that needs to be permanently imported from GM, will be imported. As the project matures, less and less will be imported and local manufacturing is expected to reach the maximum of 65%. This objective will be attained in the span of ten years to be divided into two phases: In the first phase (1987-1991) production will start with 40,000 cars (10,000 small and 30,000 mid-size) which is the present production capacity at NASCO. By the end of the first phase, the percentage of locally manufactured parts will reach 52%. By the end of the second phase (1991-1996) production will reach 81,000 cars (31,000 small - 50,000 mid-size) and the percentage of locally manufactured parts is expected to reach its maximum of 65% of the value of the car. 4. The c.k.d. list (or list of components constitut ing a car) will be mutually agreed upon so that the cost of each part is represented by a certain percentage of the 58 value of the car. This policy of specifying percentages rather than prices is followed to avoid disagreements in pricing. 5. GMCC is allowed to sell cars in the local market for hard currency with a maximum ceiling of $40 million/year. The rest of the production is planned to be exported. 6. All technology and training of employees required for the achievement of the project will be provided by GM. 7. The project is planned to be completely self financing with GM playing a major role in that concern. The heaviest financial load on GMCC is in the importation of components, that cannot be manufactured locally, from GM (approximately 35% of the car). In its proposal GM has suggested to do the following: a) export and market a portion of the locally manufactured components, b) export a certain amount of Egyptian non traditional commodities, c) promote tourism in Egypt by arranging for a minimum of 50,000 people to visit every year. Revenues from all three of these sources will go to GMCC for the importation of components from GM. b. Benefits to GM from Proiect The benefits to be achieved by GM as a result of this project are several: First, given the GM imposed condition 59 that, other than GM, no small or mid-size cars are to be produced or imported by Egypt as long as the contract is valid, it has guaranteed a market for its components in Egypt for ten years and probably longer if the contract is extended. Second, since GM is a partner in the GMCC joint venture, it gets a share of the profits made from selling cars both locally and internationally. Third, through its proposal, GM has shown a lot of good will for helping Egypt and has thus gone one step ahead of its competitors. It has opened the door for further business in Egypt. Fourth, arranging for 24 component-producing joint ventures is likely to benefit GM in an indirect way. Since the foreign partners in these joint ventures are the actual producers with which GM deals in its own production lines, they will probably return the service by preferential treatment for GM as is often witnessed in similar arrangements. c. Benefits to Egypt from Proiect The benefits to Egypt from getting involved in this project are several: first of all, in the span of ten years and for the first time, Egypt will be able to locally manufacture 65% of the value of a passenger car. This goal was never achieved through Egypt's previous cooperation with FIAT. After twenty five years with FIAT the local content never exceeded 15% of the value of the car which 60 means that the project never went beyond the assembly stage. Second, it is a great advantage to Egypt to have the widely reputed GM participating in the local production of cars and transfering their up to date technology to the Egyptian industry. Third, the establishment of the 24 joint venture feeding industry, along with the above explained features of the project, will create a solid base for the production of passenger cars in Egypt. Eventually, Egypt could very well be capable of producing and designing its own cars. Fourth, the countertrade portion of the project is quite advantageous to Egypt as it relieves the government of any additional financial burden and promotes new kinds of exports. Fifth, the project has been arranged so that NASCO works at maximum capacity at all times. This means that the company will improve its technology without having to suffer from any underutilization of its resources while making the transition from assembling FIAT cars to producing the new GM cars. The project is beneficial to NASCO in two other respects: 1. as a partner in the GMCC joint venture, NASCO receives a share of the profits achieved from sales of cars; 2. The subcontracting relationship between GMCC and NASCO entitles the latter to 61 subcontracting fees for each car produced. last but not least, it is estimated that up to 5000 job opportunities could be created as a result of this new project. d. Comments 1. The importance of the GM project goes far beyond its being a huge project for the production of passenger cars. It is the first of its kind to be implemented in Egypt and all neighboring countries. The financing arrangment, in particular, is brand new and quite appealing to LDCs. According to officials, the GM project is an experience that is currently watched by several countries and if successful will be imitated. 2. The project is also important, from a studying point of view, because it tells us more on the nature of countertrade agreements and the different varieties they can take. The GM project is not a simple industrial compensation agreement where GM produces cars in Egypt and is paid back in cars. Instead, it is a combination of joint ventures, subcontracting and countertrade. Counter trade appears explicitly only in the financing of the project. We also note that many parties are involved: GM on its own, GMCC, 24 other joint ventures, NASCO and AAV. Moreover, all of these parties are not completely separate from each other. There is a subcontracting relationship 62 between GMCC, NASCO and AAV. Also GM and NASCO are coowners of GMCC. The numerous parties involved contribute to the sophistication and subtle nature of the countertrade proj ect. 3. The complexity of the project, however, raises a lot of questions as to how this project will affect the Egyptian economy, the possible exploitation on the part of GM and the practical problems to be faced as the execution of the project proceeds. Egypt seems to be aware of some of these problems and has tried to account for them in the negotiations with GM. According to the Minister of Industry, it was during the negotiations with Egyptian officials that the GM proposal has been arranged to make sure NASCO facilities are exploited al all times to avoid any underutilization of its facilities. Also important is the specification of all c.k.d. parts as percentages of the total value of the car as opposed to specifying prices. This pricing system attempts to avoid the exploitation on the part of GM when Egypt imports its components. However, many details concerning various prices charged on both sides and the operation of the project have not been revealed by the authorities, which means that whether•there is or isn't exploitation on the part of GM cannot be determined at the present time but rather later when the project is executed. 63 4. In general, the project represents a very interesting case study for countertrade. It reflects how flexible a countertrade project can be. It can be molded in any way, and even added to things like joint ventures and subcontracting, to suit the interests of all parties involved. 4.4 An Evaluation of the Egyptian Experience with Countertrade and a Look at its Future It is very unfortunate that an adequate evaluation of the present Egyptian experience with countertrade is not possible for several reasons: first, there is not enough data to allow any quantitative or statistical work of significance. Second, since, at the present time, countertrade is limited to only a few transactions, it does not yet affect the economy in any noticeable way. Third, even the countertrade transactions that have actually taken place, like the ones discussed above, are either in the approval stage or only at the beginning of their execution. In either case the possible problems that could be witnessed in the execution stage cannot be pinpointed. Of particular importance is the GM project discussed above. The project is not really accomplished before 10 years and even then, given its nature, it will take several years after to see how the project is really performing and if 64 there are any long term effects on the economy. What we can say, however, is that countertrade, at least in the short run, opens doors for the LDCs that would have never been open under the traditional multilateral trade system mostly because of the present distortions in the international trade environment, the shaky worldwide financial situation and the external debt problems of these countries. Countertrade has the unique property of simultaneously achieving several targets for an LDC. For instance, the approval of NEC's countertrade proposal means not only that the production of NEC TVs becomes self financing but also that tourism is being promoted. Moreover, the possibilities of proceeding with its development plans and acquiring Western technology without worsening its external debt problems are among the numerous advantages that LDCs obtain through the use of counter trade . While we have discussed above several of the problems that may be associated with countertrade, it is important to note that any costs associated with countertrade are of significance only when compared to the possible expense an indebted LDC has to incur if it tried instead to follow traditional multilateral trading practices. Countertrade, however, still cannot be seen as the solution to all of Egypt's economic problems. The benefits of Egypt's 65 extensive efforts to increase exports and save on its hard currency reserves via countertrade or any other method, will soon fade away unless they are collaborated with serious attempts to solve Egypt's other compelling problems such as inflation and inefficiencies in the public sector. As for the future of countertrade in Egypt, it seems to be the case that barter will not remain as the only prevalent form of countertrade, a trend towards more counterpurchase and industrial compensation agreements is likely for the following reasons: First, Egypt is beginning to see in countertrade advantages besides the improvement of its deteriorating balance of trade and the preservation of hard currency, such as the ones presented above. Second, the government is encouraging the private sector to get involved in countertrade transactions which means that countertrade is likely to play a more significant role in future Egyptian trade. More importantly, it will probably constitute a permanent ingredient in its future development plans. Third, countertrade is expected to become more prevalent because it is increasingly becoming a precondi tion for doing business in Egypt especially in the field of industry. According to officials, Egyptian companies* seeking the expertise and partnership of various Western companies are increasingly requiring countertrade especial ly in the form of industrial compensation. The companies 66 also reveal preference for Western partners that are willing to assist with exports beyond what is needed for f inancing the project. Table 4-1. Egypt: Export Import Ratio for the Per iod 1970-1983. Year Exports* Imports* ‘ /. 1970 1 A » X- 262. 1 126 1971 343.2 318.3 108 1972 358.8 313.0 146 1973 444. 2 281. 9 158 1974 593. 3 795. 7 75 1975 548. 6 1279.0 43 1976 595. 4 1085.1 55 1977 668.5 1317.0 51 1978 679.8 1773.4 38 1979 1287.8 1862.9 69 1980 1 o o 4- 1 U 4 . « W 2569.1 83 1981 2263.0 4599.2 49 1982 2184.1 4762.1 46 1983 2250.3 5087.3 44 * Values in million Egyptian pounds Source: (Report on the National Conference for Export, 1 9 8 5 ) p . 2 Table 4-2. Baxter Agreement Between Egypt and Various Other Countries* (1985 & 1986) Country Value In Million $** Most Important Egyptian Exports Most Important Country Export Sudan 1985 15 Medicines, Aluminum products Sesame seed, Leather Sudan 1986 28 Medicines, Rice Sesame seed, Leather Jordan 1985 110 Cotton, Textiles, agricultural products, flowers, perfumes, medicines, canned food, shoes, handi crafts, Carpets Cement, Construction materials, Paper, Paint, insulating ma terials, Ceramic Tunisia 1986 20 Raw cotton, Cotton yarn, Sulpher, Other nontradltional exports (unspecified) Electric products, Construction materials Austria 1986 24 Fruits, Vegetables, Rice, Seeds, Essential oils, Phosphate ^Un derwear, Perfumes, Furniture, Beans Wood, Paper, Organic and nonorganic chemi cals, iron Romania 19 8 6 62 Leather products, Charcoal, Ready made clothes Wood, Iron, Cement, Paper * Duration of execution for all agreements is one year. ** Value In table refers to total value of transaction. I.e., the obligation of each Individual country is only half the amount In the table. Source: Collected from Information Provided by Officials i n the Egyptian Government and Al-Ahram Newspaper (1985-1987) 69 Table 4-3. Barter Agreements Between Egypt and various other countries In 1387 * Country Value in Million $** Most Important Egyptian Exports Most Important Country Export Lebanon 11 Vegetables, Fruits, Potatoes, Ready-made clothes, Under-wear Glass, Cement Holland 50 Vegetables, Potatoes, Cotton yarn. Iron products, Flowers, Fruits, Juices, Furni ture, Tires, Phosphate Tobacco, Other prod ucts (not specified) Holland*** 95 Vegetables, Potatoes, Cotton yarn, Iron products, Flowers, Fruits, Juices, Furni ture, Tires, Phosphate Up to data machinery for land reform pur poses West Germany*** 24 Fruits, Rice, Tex tiles, Phosphate , Salt, Ready made clothes, Aluminum products Construction materi als, organic and nonorganic chemicals, Raw materials for pro duction of medicine Sweden*** 24 Metals, Agricultural products. Textiles Chemicals, Spare parts for machinery, Paper * Duration o£ execution for all agreements Is one year. ** Value in table refers to total value of transaction, i.e., the obligation of each individual country is only half the amount in table. *** The agreement with Holland, West Germany, and Sweden are very recent. *11 three were signed between July and September of 1987. Source: Collected from information Provided by Officials in the Egyptian Government and Al-Ahram Newspaper (1985-1987) CHAPTER 5 ROMANIAN CASE STUDY There are several reasons behind choosing Romania for study. First, Romania is the only EEC which legally mandates countertrade. Second, Romania has the reputation for being one of the most difficult countries with which to negotiate countertrade deals, thereby raising the question of why this is the case. Third, unlike most other EECs, Romania allows both direct foreign ownership and contractual rights to equity through licensing and technical service agreements. In other words, Romania is a country where both direct foreign ownership and counter trade coexist, thereby refuting the notion that Communist countries resort to countertrade only because the special nature of their economies does not allow for the existence of "capitalist" forms of investment like DFI. Last, but not least, Romania has been involved in several long term, and large scale, countertrade agreements with Western companies on which some information is available in the literature. Given the limited availability of useful literature on countertrade in general, the importance of this information cannot be overemphasized. Moreover, any details on such long term transactions should allow us to closely examine their effects on both Romania and the 71 Western companies over an extended period. The long term countertrade agreement that we investigate here covers the period from 1967 to the early 1980's. This chapter is organized as follows: the official attitude of Romania towards countertrade is described in Section 5.1. It begins by briefly describing the general economic environment that led to the use of this unconventional form of trade. It then moves on to the mandating of countertrade in Romania and a listing of the most important governmental agencies actively involved in countertrade transactions. The section culminates with a description of the most prevalent forms of countertrade in Romania. Section 5.2 describes several facts about countertrade in Romania. These facts are derived from the experience of various Western companies. The goods and services offered for countertrade and their quality, contractual considera tions and the factors lying behind Romania's reputation as a tough bargainer are among the issues raised. Finally, section 5.3 is confined to the study and analysis of the large scale countertrade agreement between a British company (British Aerospace) and the Romanian Foreign Trade Organization (Tehnoimport). A sample of countertrade 72 contracts between Romania and its Western partners, along with the relevant letter of guarantee, are presented in appendix C. 5.1 The Official Attitude of Romania Towards Countertrade 5.1.1 The Environment for Countertrade in Romania The economic pressures faced by the East bloc as a whole and that encouraged the use of countertrade were extensively explained in chapter 2 above. With respect to the specific case of Romania, it was found that, in the past, Romania had relied heavily on Western exports. In 1980 alone it was $500 million in the red to the West. Although Romania's aggregate trade balance with the West and LDCs during 1975-1981 (table 5-1) reflects vast improvement especially in 1981, it was still deeply in debt to the West. As shown in (table 5-2) Romania's net hard currency debt more than doubled between 1978 and 1981. This condition plus the debt repayment crunch has forced this nation and others to allocate an inordinate portion of their foreign earnings to debt repayment than to the finance of imports, in practice prompting Romania to' institute an austere plan for 1980-1985. The planners are counting on the five year plan to develop more competitive exports and to reduce imports such as raw materials and 73 energy (Welt, 1984a). Given that the ultimate target of Romania is to revitalize its hard currency earning power so as to reduce its trade deficit with the West, the self-financing and export-expansion aspects of countertrade certainly make this form of trade attractive for the Romanian authorities. 5.1.2 The Mandating of Countertrade in Romania Compared to other EECs, Romania has always demanded some of the highest counterpurchase percentages in any individual countertrade transaction. In 1980, however, Romania passed a law (law #12) mandating countertrade. This law states that countertrade must be used to reach a favorable balance in international trade. This is accomplished by tying individual FTOs countertrade requirements to its import level and hard currency availability. The law also made the starting point for any negotiations with the West 100% counterpurchase for almost all imports (Welt, 1985; Verzariu, 1985). Romania's recent legislation illustrates the evolution of countertrade toward an institutionalized form of commerce. The law is an announcement both to the outside Western world and to the local FTOs that more serious attention should be given to this form of trade because of its obvious benefits given Romania's economic problems. 74 The legal mandating of countertrade is surprising, however, because the special nature of Eastern command economies accomodates countertrade demands without the need for a formal expression of policy. FTOs in EECs are typically instructed via internal administrative directives as to the extent they must participate in countertrade. While there is no specific information as to exactly why Romania decided to mandate countertrade, our speculation that this step was motivated by Romania's difficult economic problems and its plans to solve them as described above would be quite reasonable. Along with the 1980 law, specific guidelines are provided by the various Romanian industrial ministries to the FTOs setting forth overall annual countertrade goals in accordance with established export targets. Furthermore, the Ministries of Foreign Trade and International Cooperation and Industry closely monitor and involve themselves directly in contract negotiations to ensure the fulfilment of their countertrade directives. 5.1.3 Government Agencies Actively Involved in Counter trade Although most Romanian FTOs prefer to involve themselves directly in the countertrade transactions which they have contracted, Romania has designed several 75 organizations to handle specific functions in the field of countertrade. For instance, the FTO Terra handles Romania's countertrade, barter and switch transactions in third countries (i.e. LDCs and other EECs). As a Romanian countertrade trading house which is responsible directly to the Ministry of Foreign Tracle, Terra handles speculative import-export transactions on its own account and can invest jointly with foreign parties in projects both in Romania and abroad. It is authorized to raise credit abroad outside of the channels of the Romanian Bank for Foreign Trade, which nevertheless, guarantees such credits. Delta is another government trading house whose duties parallel those of Terra and additionally include the export of licenses and knowhow plus engineering consulting. Another example would be the agency Mercur which is responsible to the Ministry of Interior and specializes in swapping Romanian consumer goods for foreign consumer goods. Another FTO, Ileseim, acts as a clearing house for countertraded goods from light industrial sectors such as consumer goods, furniture, ceramics, glass, clothing and small tools. Moreover, the planning department, a special section of the Ministry of Foreign Trade and International Cooperation, has a separate office for coordinating counterpurchases among various FTOs throughout the country (OECD, 1981). 76 Finally, these organizations have the additional job of helping Western companies dispose of countertrade goods. Should a Western firm reject the services of the Romanian organizations and dispose of the goods on its own, the Romanian party to the transaction attempts to impose certain restrictions to protect its own markets by placing limitations on where goods are to be sold. They might also insist that any third parties be located in the seller's nation or at least in the West. This insistence is one of the reasons behind Romania's reputation as a tough negotiator. There are, however, several others which are discussed in the next section. 5.1.4 Most Prevalent Forms of Countertrade in Romania Because industrial compensation offers numerous advantages for the EECs, it is the largest and fastest growing form of East-West countertrade. Industrial compensation transactions assure the EECs of a steady, relatively long term market for the goods involved. Because this form of countertrade involves the importation of Western technology and the application of Western quality control standards, it also tends to upgrade EEC manufacturing standards. Industrial compensation agree ments and other cooperation deals with elements of compensation are tailor-made to cure such EEC ills as low 77 product quality and stagnant exports. Unfortunately, due to the lack of data and the confidentiality of most important transactions, we cannot indicate the significance of industrial compensation relative to other forms of trade. We were able to find some industrial compensation estimates for the period 1969-1980 from OECD reports (tables 5-3 and 5-4). According to this data, Romania was not among the heavy users of industrial compensation in the indicated period especially when compared to Poland and the USSR. It is important to note, however, that as indicated by OECD there is a rather wide margin of error in this information, in part because most of the data are based not on hard figures but rather on estimates and interviews. Also, as a result of the lack of consensus on the definition of countertrade and its various forms, different sources classify the various transactions in different ways. Other forms of countertrade like counterpurchase and barter also exist in Romania. However, they are much harder to quantify and statistics for these forms of countertrade do not exist in any significant manner. Some interesting examples are scattered in the literature,' however, such as the 1983 General Electric (GE) agreement with Romania. GE renegotiated its $150 million contract, signed 2 years earlier, with Romania involving the supply 78 of steam turbines in conjunction with the sale of Canadian nuclear reactors to that country. Under the new terms, GE agreed to receive 50% of the specified payment in Romanian goods, the other 50% in cash (Verzariu, 1985) . While it is hard to detect the empirical significance of countertrade when compared to other forms of trade, the pressure for countertrade is growing especially following the 1980 law. Consequently, the future is likely to witness more countertrade both in the form of industrial compensation and in other forms than has been recorded so far. 5.2 Countertrade in Romania Based on the Experience of Various Western Companies' 5.2.1 Countertrade Requirements in Romania Based on the experience of various Western companies involved in business with Romania, the level of countertrade demanded by the Romanians varies from sector to sector and from case to case. For example, firms in the engineering area such as Machinoexport and Electronum usually receive a 50% countertrade provision in their * agreements whereas 35 to 50 percent is typical for the purchase of machinery in the chemical industry and 30 to 50% for light industry. While these are the average rates, 79 from 1976 to 1979 there had been a noticeable increase in the average counterpurchase percentage required from the Western partner for all forms of countertrade from 30-40% to 50-70%. While all negotiations formally begin by the government demanding 100% counterpurchase for all imports, it tends to decrease, in the way explained above, as negotiations proceed. How favorable the terms the Western firm can obtain will ultimately depend on the importance of its products and on the availability of competitors who may be willing to provide similar goods under different terms. In general, however, Romania does not reduce its counterpurchase requirements in the process of negotiations to the extent that other EECs do (OECD, 1981). 5.2.2 Goods and Services Offered for Countertrade in the East Bloc in General and Romania in Particular a. Countertrade in Goods Exports available for countertrade vary from one EEC to another, the choice depending on several factors. These first include the type and volume of goods produced by the country each year. In general, FTOs prefer to offer finished goods rather than raw materials. The demand for the goods in hard currency export markets is also an 80 important factor. Goods that can be sold for hard currency are usually not available for countertrade. The period of the year when the obligation of the Western partner is supposed to be fulfilled also plays a role. For instance, buying the Romanian goods during the last quarter of the calendar year is the best time because this is when the FTO is trying to fulfill its export targets. Raw materials or other commodities that can be sold without difficulty in hard currency markets may be made available for counterpurchase only when necessary to insure high priority Western imports, and these are usually quickly used up. These products will appear on lists of goods offered for export and /or counterpurchase by FTOs to Western exporters even when they are no longer available. Delivery of counterpurchase goods chosen from such lists is subordinated to any export bids the FTO may receive for these goods prior to the commitment deadline to the Western party. Manufactures in fulfillment of counterpurchase commitments generally have low priority in any EEC's production planning. As a result, delayed deliveries of counterpurchased goods are common and these products are generally lacking quality, spare parts, after sale sefvice and packaging. Romanian products offered for countertrade range from forestry products to consumer goods, machinery, light 81 industry goods and chemicals. Most of these goods suff^_ from inflated prices, poor quality and lack of after sale service. In 1980 55% of all goods counterpurchased were in the machinery category. This rate is the highest among all other EECs (Verzariu, 1980; Welt, 1984a). b. Countertrade in Services Services offered by different EECs for the fulfillment of Western countertrade commitments are slowly but constantly increasing their share in total countertrade turnover. The major reason for accepting services instead of products in countertrade is the poor quality and servicing of EEC goods. From the experience of Western companies, however, countertrade in services is no easier to contract and fulfill than countertrade in goods. Western companies usually have to prove that the services accepted are for in-house purposes or at least are used by subsidiaries. Examples of services include: assuming cost of transport orders, deducting the costs of office rental and using facilities to fulfill tourist quotas. The most attractive services are offered by Bulgaria and Poland. Negotiating services in fulfillment of countertrade obligations is relatively simple in countries where all foreign trade transactions are supervised by the Ministry of Foreign Trade, as in Czechoslovakia, Hungary and the 82 USSR. In Bulgaria, East Germany, Poland and Romania where separate industrial ministries still operate, there is less flexibility in that respect (Business International, 1983). The three most common countertrade services offered by Romania are: 1. Design and Construction Work Romanian firms may serve as general or subcontractors of (petro)chemical works built in LDCs. According to various Western companies, however, end-users often complain that various types of adjustments and replacements of technical components were necessary in newly commis sioned Romanian-made plants in order to make them operative. 2. Transportation According to Western sources, however, transport services proved to be a failure unless undertaken on a bilateral basis between the commited Western companies and their Romanian partners. In such cases negotiations take place with the Romanian importer who assigns the transport of the goods from the Western factory to the FTO Romtrans. When used on a large scale, however, like when having Western goods transported on Romanian trucks to the Middle East or other destinations, delivery delays occur very frequently. The main reason for that is the generally poor technical condition of Romanian trucks which makes 83 breakdowns highly probable. According to Western firms which have gone through this experience, delivery delays ultimately affect the Western supplier's, rather than the carrier's, reputation with the buyer. 3. Research Assignments Assignments to research institutes and laboratories related to the Romanian importer can be linked to countertrade. However, apart from the sectoral limita tions, Western companies also complain of the poor quality and late delivery of the research completed. The best results have been obtained in the fields of human and veterianary medicine, and in petrochmical downstream processes. The picture described above for Romanian supplied countertraded goods and services applies only to the commercial compensation form of countertrade. It does not apply, however, to industrial compensation as defined in this study because, according to the latter definition, payment for the original transaction is only in the form of goods or output derived from this particular project. It is also interesting to note that while industrial compensation is supposed to be the most common form of countertrade in Romania, the experience of Western companies as described in the scattered literature 84 available on Romania, and as presented above, does not even comment on this form of countertrade. This may be due to the fact that most of these transactions are confidential. 5.2.3 The Factors behind Romania 's Reputation as a Tough Bargainer in Countertrade The Romanians, along with the Bulgarians, have earned a reputation for being the most hardnosed and shrewdest bargainers with the West in countertrade negotiations. In fact, in the case of Romania, many Western exporters have foregone doing business with its various FTOs because of the country's reputation for very strict countertrade policies affecting all sectors of the economy. Starting with a mandatory 100% countertrade demand, Romania's FTOs do not bargain down as far as most other EECs. A favorite ploy of Romanian negotiators is to make countertrade demands after the Western partner has already quoted a selling price that is too low to absorb countertrade costs. However, Romania's reputation does not rest solely on high countertrade demands, but also on exceptionally poor quality products. Products that are often over-priced and for which spare parts are not available. Also, negotiated prices do not include after-sale service. Delays caused by problems of avail ability and delivery of products are very common in Romania 85 __ and can seriously disturb a company's operational and marketing timetable. According to the experience of various Western companies, Romanians often stretch out even simple counterpurchase agreements to at least two or three years. At the same time, they insist on having Western partners fulfill their countertrade obligations on time. If a Western firm has difficulty fulfilling its countertrade commitment, it will not find its Romanian partner very sympathetic. For example, the Ministry of Chemical Industry grants a contract extension only if part of the agreement has already been met. The FTO Masinimportexport demands higher countertrade or other concessions before granting extensions. If extensions fail to provide Western companies with enough time to fulfill their obligations, the Romanians demand unconditional penalty guarantees issued by a foreign trade bank and payable on first request. In deals involving machinery and vehicles, the Romanians have demanded penalties of 20-30% of the imported product's worth. In deals involving chemicals Romania has demanded 10-15 % penalties. Another sign of strictness on the part of the Romanians is that they tend to impose certain restrictions on their Western partners in disposing of the countertraded goods. They may protect their own markets by placing limitations on where the counterdraded goods can be sold as 86 explained above. Finally, Romanian authorities seek to restrict counterdelivery to the original importing FTO or the industrial ministry to which the FTO is responsible. Exceptions may be made, however, for important deals upon the intervention of the Ministry of Foreign Trade (Verzariu, 1980; Welt, 1984a; Elderkin and Norquist, 1987). 5.2.4 Countertrade Contracts in Romania and Other EECs The drafting of a countertrade contract with an EEC usually requires protracted negotiations. The FTOs normally provide the Western exporter with standardized contracts, especially for countertrade obligations that do not exceed one or two years. Although the FTOs prefer to adhere to the format of their contracts, the Western parties usually negotiate amendements to such contracts to suit their particular needs. The following listing includes clauses usually found in frame contracts (entries 1 through 5), and additional ones that may be negotiated in countertrade contracts (entries 6 through 13). The contract clauses refer to: 1. The responsible parties to whom the countertrade commitment can be transferred (e.g., a trading house); 2. The value of the countertraded goods, often expressed as a percentage of the Western export contract, and the purchase deadlines; 3. The list(s) of available goods offered for 87 countertrade and the FTOs through which they are available; 4. The penalties for nonfulfillment or delayed fulfillment of the countertrade obligations; 5. The seat of the arbitration court and the governing law in case of legal conflicts; 6. The quality of the countertraded merchan dise as being of export standard and offered at internationally competitive prices; 7. The right to link the countertrade purchase from several FTOs for any goods actually available in the country; 8. The right to choose a neutral surveyor, selected by both parties, to pass a binding judgement on the quality of the countertraded goods, in case the concerned Western party finds them unacceptable; 9. The right to deduct from the amount of the countertrade obligation all or part of the countertrad ed goods making up an order from the Western party, if these goods are not available or do not meet the contracted deadline; 10. The right of the Western party or to market the countertraded goods in third country markets of its choice without interference from any of the EEC's FTOs; 11. The separate and distinct obligations relating to penalties for nonperformance by the Western party and payment obligations by the importing FTO; 12. The provision that the contracted countertrade obligation would be legally annulled in case of cancellation of the Western export contract (Verzariu, 1980). 88 Appendix C contains a sample of a countertrade frame contract for the case of Romania along with the letter of guarantee that goes with it. It can be noticed that while the necessary clauses described above are included, the additional optional clauses providing guarantees for the Western partners are absent (from 6 on). Also, there is a considerable stress on the penalties that the Western partner would have to face in case of nonfulfillment of its countertrade obligations. The latter two points illustrate the toughness of the Romanian negotiators as described above. From the information presented above, one can conclude that Romania is a typical and at the same time atypical EEC in its involvement in countertrade. It is typical in the sense that it has faced the same economic pressures that forced the other EECs to get involved in countertrade. It is also typical in the general character of its countertrade policies. It is atypical of other EECs, however, in the drastic measure it took in mandating countertrade and in its unwillingness to decrease its countertade demands. 5.3 Industrial Cooperation Between British Aerospace and Romania This case study is an account of the experiences of 89 British Aerospace (BAe) in the marketing of freight and passenger variants of the BACl-ll to Romania. The case describes the activities of the company in this market over a number of years, but more importantly demonstrates the major role played by countertrade when exporting to the EECs (Hill, 1983). 5.3.1 The Romanian Market 1967 to 1973 The Romanian business interest commenced in 1967 when BAe (or BAC as its name was at the time) learned that the Romanian FTO , , TehnoimportM, had recently initialled a contract for the supply of a specific type of aircraft from a French manufacturer. The British company which believed its products performed better than the French aeroplane sought the approval of the FTO to enter the competition. During subsequent discussions with Tehnoiroport, it became apparent that the purchase decision was being influenced by several factors: (1) the need for Romanian airlines to compete in the Western tourist and scheduled markets with a modern jet, (2) the necessity to generate sufficient foreign currency from the sale of Romanian goods in Western markets to assist in meeting payment schedules for the fleet, and (3) the Romanian desire to re-create a modern aircraft industry preferably through cooperation with a Western partner. 90 BAC consequently considered it necessary to make a proposal which was sufficiently original to commend itself to the unique conditions prevailing in Romania. This was particularly important at a time when the French competitors were proposing a major industrial cooperation through sub-contracting the production of helicopters. Such a project on the part of the French could encourage Romania to buy from them the passenger aeroplanes it needed if the British proposal were not sufficiently attractive. BAC attempted to find several Western partners who would be willing to do business with Romania. This business if approved by the Romanian authorities would bring in foreign currency that could help Romania pay for the aeroplanes. This arrangement is called a "frame agreement". It usually consists of a general contract which links together several independent contracts between different parties, both buying and selling. Although it is nothing but a combination of counterpurchase and industrial compensation agreements, the frame agreement in itself is often referred to in the literature as a separate form of countertrade (OECD, 1985). BAC, which had previous experience with countertrade in other EECs, arranged for three of these independent contracts: a. Contract #1 The parties involved in this first agreement were the 91 British Britten-Norman company and Tehnoimport. The British company which commenced its business activities in the conversion of aircraft for use in agricultural aviation, had recently developed the twin-engine Islander aircraft to meet the specific needs of air taxi companies, commuter airlines, and other short distance carriers. In view of limitations in factory space, however, it was only possible to produce one aircraft per week there, whereas market demand was buoyant at ten aircraft per month. In the fall of 1967, therefore, BAC arranged for Britten-Nor man to meet with Tehnoimport and a production plan was negotiated. This arrangement was included in the frame contract in February 1968, and called for the Bucharest factory to deliver 215 Islanders according to a specific schedule. This contract matched the requirements of both sides since Britten-Norman secured production capacity of acceptable quality at reasonable cost, whilst the renascent Romanian aircraft industry benefited from both the production experience and the steady sterling income. The total value of this offset contract was £1.333 million payable to Tehnoimport for aircraft assembly work, and BAC agreed to pay a linkage fee of 9% of that value to Britten Norman. This term linkage fee is frequently used in countertrade practice to describe a fee that is sometimes 92 paid by a Western exporter to a Western importer for linking its purchases from the same socialist country to the seller's exports. b. Contract #2 Another party nominated in the frame contract to buy from Romanian FTO under Tehnoimport's coordination, was a trading company based in Switzerland which had an interest in building up its business relationship with Romania. This trading company agreed in negotiation to increase its counterpurchase obligations from $7 million to $15 million of Romanian products, with no linkage fee payable by BAC. c. Contract #3 BAC's last nominee as parties in the frame agreement was a British machine tool importer. It was agreed that the importer would purchase Romanian machine tools worth £50,000 per year, for a period of ten years, giving a total purchase value of half a million pounds sterling, in consideration of which Masinimport granted him an exclusive agency in the UK for Romanian machine tools. The British government quota of £35,000 per annum of Romanian machine tools was increased to £50,000 to facilitate this arrangement. There was no linkage fee to be paid but- BAC agreed to introduce and absorb the machine tool imports for the first two years with a 15% mark-up to cover servicing and normal profit. These machine tools were subsequently 93 used in BAC's apprentice training schools. The frame contract was finally signed in February 1968 following only six months of negotiations and was fulfilled by conclusion of all the parallel contracts with terms of credit on the aircraft in May 1968. BAC was to sell six BAC 1-lls and spares to Romania. This total contract price of over £10 million to be paid by Romania would be about 80% covered by the total of its exports of machine tools (£0.5 million) to the British agent, the aircraft to Britten-Norman (£1.33 million), and other products to the Swiss trading company (approximately £6.25 million). Furthermore, the Romanian side received some seven years credit for their purchases, although it was usual for only short term credit to be extended to their purchases. Finally, the BAC 1-11 fleet entered the Western routes with a high foreign exchange earning potential for the Romanian TAROM airline. The only offset cost to BAC associated with this countertrade agreement, was some £120,000 in linkage fees to Britten-Norman, and some £115,000 in machine tool purchases from the importing agency. Although different Western parties to the framework agreement were dealing with different Romanian FTOs, the Ministry of Foreign Trade coordinated these parallel agreements on the Romanian side. Since BAC had originally found the Western parties to the parallel agreements, they 94 acted as coordinators on the Western side, but no liability was attached to BAC for the failure or success of the parallel contracts. We finally note that the parallel arrangements generally worked well from the view point of all parties involved with only minor delays due to initial familiarization with the Romanian factories. 5.3.2 The Romanian Market 1973 to 1976 In 1973 Tehnoimport declared itself interested in the purchase of a fleet of five BAC 1-11 500 series aircraft. These planes were larger than the ones previously sold to Romania. They were needed by Romania to cope with its high economic growth rate and increasing passenger traffic. It is interesting to note that, due to its previous successful experience with the British company BAC, Romania contacted them first. At this time, however, BAC was suffering from some internal problems because it was in the process of changing from a private to a public company. Sensing BAC's uncertainty, the Romanaian side invited proposals also from McDonnel-Douglas (MDC) and Boeing aircraft companies, both of whom responded with enthusiasm as they were both keen to step into any market vacuum left by BAC. Since market penetration at this level for either American competitor could spell major business in the future, BAC decided to attempt to maintain the Romanian interest while trying to 95 solve its internal problems. It believed that it was in a position of relative strength because it had dealt with Romania before. It was in 1974 that the negotiations started and the focus was not just on price but also on the countertrade offered. What was different this time, however, was Tehnoimport's directive from the ministries. The old insistence on "compensation" in sundry goods to a certain level had given way to an ideological and practical preference for "offsets" within the same sector of the economy as that to which the sale was being made. It followed that whereas all three contenders had to offer . basically the same thing, it was the calibre of the offer that would count. BAC in conjunction with another British company offered the Romanian aircraft industry sub-contracts on future batches of BAC 1-11 components. BAC knew that these components incorporated technology and techniques new to Romanian, which they were keen to learn, and therefore remained firm with its proposal. At the same time, it made its offer more appealing to the Romanians by offering to import technology and loan jigs and tools free of charge as part of the package. By this offer it managed to win the deal from its two American competitors who were less acquainted with the Romanian market and its needs. 96 The basis of the business deal was another framework agreement, which was signed on the 30th of December 1974. The value to BAC of the contract for 5 aircraft with spares was some £17.5 million. Several contracts accounted for viable offsets of over 20% created directly within the aeronautical sector. The BAC 1-11 525's series went into TAROM's European and North American Airlines in 1977 according to plan. 5.3.3 The Romanian Market 1976 to 1979 The first sign of further business between BAC ( now BAe after nationalization) came in 1976 when Bucharest asked BAe for a price on a license to manufacture the whole 1-11 airframe or alternatively the wings. Being aware of the facts that Romania is always interested in upgrading its technology, that had already been involved in the production of several complicated 1-11 components and was at the time involved in separate negotiations with a German company for the production of a full aircraft, BAe declined to quote a figure for the wings only but proposed £20 million for the whole airframe. By making this offer, BAe not only guaranteed a permanent market for the spare parts it knew Romania couldn't produce but also stole an important deal from its German competitors. Furthermore, BAe insisted that Tehnoimport buy a number of whole 97 aircraft from its facilities as a precursor for their construction under license. The two parties then started a series of complex negotiations involving consideration of a multiplicity of possible manufacturing programmes, each with its own price tag, whereby every part of the aircraft structure would be transfered across to a Romanian factory in a given order. Very important in the negotiations was also the countertrade agreement that would relieve Romania of its hard currency obligations. An agreement was finally reached in May 1979 with concessions made on both sides to help achieve this mutually beneficial project. 5.3.4 Current Operations Information on the operation of the project after 1983 is not known. Until that time, however, the relationship between the Romanian and British partners had been extremely beneficial for both parties and deliveries on both sides went according to schedule. BAe had taken some £250 million worth of business since the start of the operations and Romania had gained a large increase in its production capacity. As for the countertrade component of the 1979 agreement, the company had arranged the purchase of some £12 million worth of Romanian goods by British companies over a two year interval, including such products 98 and services as machine tools, fruit and travel and was continuing to fulfill the rest of its counterpurchase requirements. Comments The importance of the above case study goes far beyond the fact that it is an example of a large scale countertrade transaction for several reasons: First, it provides the details of an unusually long relationship between the two parties involved. A relationship which certainly included a series of complex and extended negotiations but was at the same time beneficial to both sides. While the exact details of the prices involved are not known, the success of the experience indicates the lack of exploitation, at least excessive exploitation, on either side. Second, the case study illustrates how the positive attitude of the British company towards countertrade in general helped it win the Romanian market in spite of French, American and German competition. This positive attitude of the company also made Romania less insistent on its countertrade demands as we've seen above (the percentage of counterpurchase required in the second agreement was much lower than that in the first agreement). Third, in reviewing the extended relationship between Romania and BAe from 1967 to 1983, a change in the Romanian 99 attitude towards countertrade is noticed. While in the 1960's Romania just wanted the Western partner to buy goods from any one, or more, of its sectors to compensate for the loss of its hard currency, beginning in 1976 the interest was in compensation from the particular sector in which the Western project was taking place. This change of attitude reflects a move to more sophisticated countertrade transactions. Fourth, the framework agreement and all the parallel contracts that were explained above once more reflect how flexible a countertrade agreement can be in its specifications to meet the needs of the various parties involved. Fifth, to the best of the author's knowledge, this case study represents the first one of its kind to be found in the literature where the relationship between the two parties has been sufficiently long for us to witness the negotiations, the beginning of the execution of the project and the actual output being marketed. Finally, the countertrade business deal between BAe and Romania remains the only jet transport ever to have been licensed in its totality from one national manufacturer to another. Another interesting point to note is that the role played by BAe appears to have had a significant effect on the market share held by British companies for relevant products in the Socialist country concerned. For example, following the signing of the first framework contract 100 between BAe and Tehnoimport in February 1968, British aircraft exports to Romania totalled some $25 million during 1968 to 1970, accounting for all of the Romanian aircraft imports from the major Western countries in 1968 and 1969, and 74% in 1970. British aircraft exports to Romania subsequently fell during 1971-1975 to an annual figure of between $1.1 million and $1.7 million, but following the signing of the second framework contract in March 1975 increased to $2.9 million in 1976, $32.3 million in 1977, and $6.1 million in 1978, accounting for some 12%, 61% and 21% of Romanian imports of Western aircraft during those latter years. These British market shares in Romania during 1968 to 1970 and 1976 to 1978 were generally larger than the British market share for total world exports of Western aircraft which varied between 8.5% and 15%. Finally, the above case study is a success story that reflects both the efficiency of industrial compensation as opposed to commercial compensation, as well as the flexibility of countertrade transactions in general when it comes to meeting the needs of both parties. The latter observation was also made when studying the Egyptian experience with countertrade. 101 102 Table 5-1. Romania: Trade Vith the Vest and LDCs. 19 75 1978 1979 1980 1981 1982 Exports 2,884 4,094 5,522 6,413 7,724 6,249 Imports 3,017 5,020 6,623 7,914 7,173 4,710 Balance -133 -926 -1,101 -1,501 + 551 1-1,530 Table 5-2. Romania: Gross and Net Hard-Curzency Debt. 19 75 1976 19 77 1978 1979 1980 1981 1982 Gross 2,924 2,903 3,605 5,221 7,009 9,500 10,700 9,770 Net 2,449 2,528 3,388 4,992 6,700 9,180 10,350 9,460 Source: (Welt, 1984a) p.145 103 1 Table 5-3. Value of Western Exports to the Eastern European Countries Under Buy-Back Arrangements. 196! 197 C 1971 1972 1973 1974 1975 1976 1977 1978 1979 1986 sub-total Under ne gotiation fcst lmatec 1969-80 Total Poland 100 1000 72 87 423 1800 i4&y 181 245 5377 371 4638 5377 to 10386 G JLtH 1*8 1126 1492 115 361 329 3601 920 3601 to 4521 Hunga rv 100 6 60 104 100 21 118 110 639 14 1131 639 to 1784 Romani a 1 4 56 172 468 6 707 442 707 to 1149 Bulgari a 16 21 62 10 105 144 109 tc 2 53 Ctechor-1 ovaVi a 1 109. 3 60 100 263 52 156 263 to 471 Total, 6 countries 100 1100 189 91 628 2001 2871 1633 614 479 790 10696 437 7431 10696 to 18564 USSR 203 500 235 873 j 007 3607 963 2717 1038 625 392 7646 19806 1850 8000 1 9606 tc 29656 Total, 7 count r i es 203 600 1335 1062 1098 4235 2964 5588 2671 1239 871 6436 30502 2267 15431 3050 2 to 1 48220 Source: (OECD, 1981) p.30 1 0 4 Table 5-4. Planned Eastern Exports Under Buy-Back Arrange ments Signed 1969-1980. (m ill ion $) Poland GDR Hungary Romania B u lg a r ia Ciccho- s l o v a k ia USSR T o ta l Coal 1 56 J 1 040 2 603 Oil p r o d u c t s VST 166 100 2 250 13 050 2 536 13 050 'F o r e s t r y p r o d u c t s 31 1 900 1 900 3 220 M e ta ls 1 002 251 34 1 900 Chemi c a 1s Tryrrspbrt Equipment 2 146 1 018 132 41 90 197 6 100 9 726 1 321 105 77 601 20 26 335 2 459 O ther Machinery 1 171 326 226 113 30 885 2 819 Consumer goods 278 66 333 41 28 50 796 O thers 146 163 49 105 20 2 260 2 943 Tota 1 8 019 2 031 891 893 191 2 SI 29 770 42 052 □ whereof : e s t i m a t e d 4 076 1 012 628 393 156 249 13 758 20 274 NUMBER OF FIRM AGREEMENTS 78 290 * I d e n t i f i e d 44 29 108 13 11 7 - Q u a n t i f i e d 10 11 27 3 3 1 . 27 82 - E stim ated 14 18 81 10 8 6 Si 218 Somrce: (OECD, 1981) p.31 CHAPTER 6 THE ATTITUDE OF WESTERN FIRMS TOWARDS COUNTERTRADE The basic purpose of this chapter is to understand the attitudes of Western firms towards countertrade. The slogan that is most repeated in the limited literature available is that Western firms are "coerced" into the use of countertrade (Welt, 1982; Verzariu, 1985). They involuntarily get involved into complicated business transactions, with lots of cumbersome counterpurchase responsibilities, for no reason other than selling some goods to an EEC or an LDC. "Half a loaf is better than none", which means a not so profitable a deal is better than no deal at all, is the way Western firms are believed to feel about countertrade transactions. Consequently, a Western firm is expected to avoid countertrade demands whenever possible. Taking this slogan as a starting point, the author's intention was to explore how the coercion of Western firms, as described above, takes place and how they choose to handle it. However, after carefully studying the experi ence of several West European as well as American firms both in the available literature and in interviews with a countertrade consultant, Dr. Demos Vardiabasis, it became clear that the above slogan is not entirely warranted. 105 While it is true that several Western firms, especially those in the US, act "defensively” towards countertrade, as described above, it is also true that several other firms have managed to use countertrade "offensively". Adding countertrade to their tool kit, the latter group of firms has managed to achieve several long term goals that wouldn't have been feasible without it. The chapter is organized as follows: section 6.1 presents some background information on how a typical firm decides upon a marketing strategy aimed at a particular export market. Section 6.2 explains the motives of, as well as the decision making process followed by, both "offensive" and defensive firms, refering to their attitudes towards countertrade. It also includes informa tion on the various assets that would qualify a firm to get involved in countertrade transactions. A detailed example illustrating the behaviour of a firm that has managed to use countertrade profitably is included in section 6.3. 6.1 How a Typical Firm Plans for Trade A typical Western firm that intends to do business with a foreign market needs to have a marketing plan or strategy aimed at that particular market. The basic determinants of such a marketing strategy are: first, the corporate values of the company which refer to its 106 prevailing policies on exporting and general criteria for involvement in foreign markets, the availability and allocation of resources to export and the characteristics of its products and technologies. Second and most important, is the information flow which consists of two parts: the top-down flow of corporate strategic thinking and the bottom-up flow of market information. While the former is internal to the firm and highly dependent on its history and the efficiency and expertise of its management, the latter constitutes "the external environment" faced by the firm. It comprises information on the political, social and economic conditions prevailing in the target export market (Verzariu, 1985; Vardiabasis, 1987). Market information is usually acquired by the firm through its various business units as well as other outside sources, such as government agencies, banks, insurance companies, specialized brokers and consultants. In today's changing trade climate of limited opportunities and rising risks, the importance of securing adequate market information cannot be overemphasized. Once obtained, however, this market information acts as a constraint on the firm's activities. The firm cannot change the external environment, it can on|y adapt to it. This last point is quite important because, as shown below, countertrade has been used by some firms to gain control over the external 107 environment to their favor. Having identified the most important determinants of the plan, the steps followed by a typical firm to bring about a marketing strategy are: 1- se|ect a target market; 2- indentify that market's objectives; 3- choose a market entry mode; and 4- monitor market performance and adjust the plan to achieve desired results. The marketing plan for each product defines a course of action over a prescribed period of time, which may vary from one to several years and sets desired objectives in a target export market. Figure (6-1) illustrates these steps in more detail. 6.2 "Defensive1 1 and "Offensive" Firms Although all firms use the above marketing strategy as their starting point, the way each one of them looks at countertrade significantly alters the implementation of the plan in the target export market. In order to clearly understand the different attitudes of firms towards countertrade, we'll divide Western firms into two hypothetical groups: "defensive" firms and "offensive" firms. A firm is classified as "defensive" when it has as a general policy not to take any part in countertade transactions unless it is necessary. Whenever possible it would avoid countertrade markets altogether. When that is 108 not possib|e, however, it would attempt to negotiate price discounts and other concessions in lieu of assuming compensatory obligations. An "offensive" firm, on the other hand, is one that looks at countertrade as an extension to its traditional export operations. Counter trade, for this type of firms, is not a cumbersome counterpurchase obligation but rather an additional tool that allows the firm more flexibility in its operations, and that opens doors that were not open before. 6.2.1 Motives for Engagement in Countertrade The motives for engagement in a countertrade transaction are different for the "defensive" and "offensive" firms. A key factor in determining these motives is the definition of success in a trade deal as seen by each group of firms. For "defensive" firms success, in a trade deal, is measured by the amount of profit collected from this particular deal. Consequently, they engage in countertrade only when it allows them to make sales which, because of the foreign exchange shortage of their customers, might otherwise be lost. Another motive is to collect past debts as in some cases when countertrade may be the only way to resolve past due accounts (Business International, 1984b; Vardiabasis, 1987). In both cases, the interest of the firm is confined to the "present" 109 revenues and profits and countertrade is a necessary evil for achieving this profit. "Offensive" firms, on the other hand, see success in a different way. They see it in both present and future benefits. While present benefits include pure profits, as in the case of "defensive" firms, they also include spin-off benefits such as the ability to retain foreign market shares, support operations of their subsidiaries abroad and others. The future benefits for these firms which are usually more significant than present ones, range from the securing of future sales in the same market to long-term targets such as securing reliable supplies of raw materials and achieving optimal capital investment for the firm by having a plan of joint production with the country in question (Business International, 1984b; Welt, 1986). A very interesting example for that special way of exploiting countertrade is the case of a US company [it's name was not revealed] that was able to postpone its capital investments for a new chemical plant because of exclusive marketing rights to the chemical obtained against the sale of technology to an EEC (Verzariu, 1985). One step further would be to use long term countertrade agreements whereby both sides could stagger their plant expansions sequentially. In this way, they would provide each other with goods from their surplus 110 capacities and could time the expansions to conform to world market needs thus optimizing capital investments. Achieving future benefits such as those explained above is of such high priority for these firms that, even if the present profits would be zero or negative, it would'nt matter at all, something completely inconceivable for firms with the "defensive" attitude. Bearing this meaning of success in mind, the motives of the "offensive" firms for engaging in countertrade are quite different from those of the "defensive" firms. By willingly accepting countertrade demands and even offering to buy back goods from the particular target country, the company builds contacts and accumulates political capital. It obtains government approval and reduces nationalistic sentiments. Also the manifestation of good will on the part of the western company enhances its opportunities to gain major sales in the future. For instance, General Electric and Northrop, as part of a sale of F-5 jets, successfully helped the Swiss to export $136 million in goods. This countertrade deal had a very strong positive effect on the Swiss government's decision to give additional contracts to those companies (Vardiabasis, 1985). Good relations, identified with mutual benefit, between a Western firm and its export market also help the 111 company maintain its market share. General Electic, for example, won a contract over its European and Japanese competitors to sell $150 million worth of nuclear power plant turbines to Romania, due to its involvement in a countertrade deal (Vardiabasis, 1985). A very important point to note here is that under countertrade competitive prices may not be as important as the willingness to participate in countertrade and this is what makes building a strong mutually beneficial relationship with the country in question important. Needless to say that a long and strong relationship with the export also makes long-term agreements, such as the ones explained above, easier.to negotiate. Finally, by using countertrade in the above explained manner, the "offensive" Western firms are actually in a way gaining control over their external environment. As mentioned above, the external environment consists of political, social and economic conditions prevailing in the export market. While this market information is typically given to the firm, the one that uses countertrade as a tool for reducing nationalistic sentiments and gaining government approval is actually molding the external ' environment to it's interest and long-term benefit. For example, a particular country may agree to get involved in a project, that it typically rejects for one reason or 112 another, simply because the Western company offered to help this country export via countertrade. In this case the use of countertrade has helped the Western company complete a deal that wasn't possible in the past (Interview with Vardiabasis in 1987). 6.2.2 The Decision Making Process of "Defensive" and "Offensive" Firms Because countertrade is looked at as evil and buying back goods from an EEC or an LDC is considered an additional cost to the firm, a "defensive" firm has to be quite certain countertrade is necessary for this particular deal. The decision making process followed by a firm to get or not to get involved in countertrade is illustrated in figure (6-2). The series of questions clearly illustrate how getting involved in countertrade occurs only out of necessity. If countertrade is a must in this particular deal, then the company tries to cut on its counterpurchase obligations as much as possible by negotiating lower compensatory terms in return for other concessions for example like: price discounts, extensions of repayment terms and extensions of performance guarantees. "Offensive" firms, on the other hand, have other concerns. Having recognized countertrade as a competitive 113 tool, that will continue to be an integral part of their strategies even if all other reasons for it disappeared, they are more interested in recognizing the best suited projects for both their own motives and those of their target export market. Examples of some of the motives of LDCs and Western exporters that result in long term countertrade agreements appear in table (6-1). When evaluating the results of the "offensive" company's involvement in compensatory transactions, the costs and problems associated with such operations are weighed against benefits resulting from related sales of the firm's goods, know-how, services, technology and spares. Indirect benefits such as the familiarization of the export market with the company goods, forestalling of competition of other firms operating in the same market, spin-off trade opportunities in third countries where the countertrade deliveries are marketed and the use of existing production overcapacity abroad are also taken into account. For these firms, any additional costs associated with countertrade are regarded as an integral part of marketing costs along with advertising and other promotional expenses. 6.2.3 What Types of Firms Belong to Each Category 114 It is very important to start by noting that the division of firms into "defensive" and "offensive" is only hypothetical for purposes of understanding the two possible extreme attitudes towards countertrade. It is more realistic to think of firms as having features of both extremes depending on the market and on the product in question. For instance, if the company produces a good that is highly inelastic in demand in this particular market and doesn't face competition from other firms, chances are it will not need to give any concessions to this market. However, if the Western company has future long-term goals, it may offer countertrade even when a cash deal is possible. A very good example is that of a major US capital goods manufacturer that concluded several industrial compensation transactions with Poland (1972) and Hungary (1976). In each case the technology offered was of such high priority to the EEC that it could have probably been sold for cash. It was to the US party's benefit, however, to consider the factories set up in EECs as additional sources of cheap component production (Verzariu, 1985). Second, despite the importance of the question above, no exact answer can be given due to the lack of detailed statistics on the operation of various firms involved in countertrade in general. For instance, even though small 115 and mid-size companies as well as MNEs get involved in countertrade, no one knows in what proportion. However, based on the available literature and interviews, one can safely say that most US firms, with the exception of few large ones like GE, belong to or lean toward the first category of firms, "defensive", while most West European and Japanese firms fit in the second one, "offensive". A reasonable explanation for that would be the fact that the latter group of countries have a much longer history of trade with EECs which means more experience with the special conditions of these countries and also more at stake, in terms of market shares, if countertrade is not used smartly by these firms. 6.2.4 Assets Needed by a Firm to Engage in Countertrade Transactions Are there any particular assets that need to be available for a firm that engages in countertrade? According to countertrade experts, given the special nature of countertrade transactions both in contract form and counterpurchase conditions, several assets need to be available for the firm. Capital is one of the important assets needed. It plays an important role in countertrade arrangements, especially when receipts of proceeds from the disposal of counterdeliveries occurs only after the Western 116 goods have been exported. During the intervening period, the Western exporter may have to shoulder costs associated with the credit extended to the importer, as well as costs that could occur as a consequence of late deliveries of countertrade goods or related to quality deficiencies (Verzariu, 1984; Vardiabasis, 1987). The availability of expertise on countertrade is also needed both in the form of in-house personnel trained to manage countertrade transactions and outside assistance such as that provided by banks and consulting firms. Finally and most important is the capacity to handle counterdeliveries. Companies that do not contemplate involvement with countertrade on a regular basis or are just starting in the countertrade field often turn to the services of trading houses. The latter organizations take over the disposal of goods for a commission. Generally speaking their services range from providing advice on countertrade practices and assistance during negotiations, to acting as brokers in countertrade transactions. A trading house's main assets are its specialists, financial resources, established market positions and international marketing network. As middlemen operating in a competitive environment, trading house brokerage margins are typically small; thus the house relies on large sales volumes and on favorable acquisition price levels for deriving acceptable 117 incomes ( Welt, 1984a). Companies that intend to participate in countertrade on regular basis, however, often establish their own trading units for handling counterdeliveries because it is more economical than using the services of an external trading house. It is interesting to note that even in the activities of their in-house trading facilities, "defensive" and "offensive" behaviour by the Western firm towards countertrade can be witnessed. Two examples of these in-house trading facilities that illustrate both extreme positions are provided below: a. Example #1 Combustion Engineering Corporation (CEC) is a diversified, high-technology US company with gross annual sales of more than $3 billion in 1983. The firm offers engineering services in steel refractory products, steam generation for electrical energy, and oil and gas drilling and exploration equipment. In the late 1960's and early 1970's, CEC became involved in countertrade through its wholly-owned sub sidiary, CE Lummus. During that period, Lummus entered into two large-scale chemical compensation deals involving design, construction and downstream services for ethylene plants in EECs with partial payment in the resultant ethlyne. In the late 1970's, CE's participation in compensation arrangements increased to the point that 118 management found it necessary to work with a mineral trading company to dispose of minerals taken as buy back. Finally in early 1980 the corporation established CE Trading, a wholly owned subsidiary to conduct countertrade transactions. The trading company was set up as a support unit with the sole function of helping operating units that face countertrade demands. It is not a profit center, and it has no legal power to compel other subsidiaries to purchase or to dispose of countertrade goods. CE Trading is directed to work hard on negotiating a cash deal, and if these efforts fail, to negotiate a minimum amount of countertrade and to accept only those goods that can be consumed or easily marketed through recognized channels (i.e. raw materials) ( Welt, 1984a). b. Example #2 Control Data Corporation (CDC) is a major company in the computer and financial services business, with annual revenues of more than $3 billion and total assets over $6 billion. The firm sells goods, services and technology in 47 countries, in such fields as education, environment, energy, agriculture, research, manufacturing among others. After being active in EECs for some 15 years, in 1973 CDC became the first US company to establish a countertrade subsidiary in a high technology field, Commercial Trading 119 International (CTI). In 1978, CDC took another step by establishing a second countertrade subsidiary, Commercial Trading Imports (CT Imports). The two units work together as a profit center to conduct countertrade. In the initial stages of its operations, CTI worked as a support unit for other CDC divisions that encountered countertrade demands in EECs. Since then it has taken an active role in initiating and negotiating countertrade transactions. As trading units in the full sense of the term, CTI and CT Imports are more concerned with buying goods at a favorable price and marketing them at a profit than with normal, contractual linkage between CDC purchases and CDC sales. By liberally following the practice of "buying forward" without specific linkage to future sales, the trading companies are free to buy goods at competitive prices and quality when they are found. The principal reason for establishing CTI and CT Imports as a profit center was to have the marketing support of an aggressive countertrade unit without having to subsidize the unit out of the profit of other divisions. There is no question that, by aggressively purchasing in the EECs, CDC's trading subsidiaries improve the corporation's marketing position in those areas. The use of watchful purchasing agents close to EEC and Chinese markets allows CDC to seize opportunities not open to a 120 company concerned only with marketing its own goods and hoping to avoid countertrade. Moreover, by looking for the best available export goods in EECs and China at any time, rather than shopping only for goods that satisfy contractual obligations, CDC's trading companies can generate hard currency for CDC purchases without having to take the slim offerings available for countertrade during a given phase of an EEC's five year or annual plan ( Welt, 1984a). 6.3 Industrial Cooperation between Massev-Ferauson- Perkins LTD and Poland The purpose of the detailed example presented below is to illustrate the behavior of an "offensive" firm that managed to use countertrade profitably. Unlike the two examples provided above, the main emphasis is not on the activities of trading units but rather on a particular countertrade transaction. The partners involved are: Poland and Massey-Ferguson-Perkins LTD (MFP), a wholly owned subsidiary of the British MNE Massey-Ferguson LTD. The agreement between the two parties was signed for the purpose of carrying out a large scale cooperation programme with the Polish tractor industry (Hill, 1984). 121 6.3.1 The Purpose of the Agreement The agreement related to the modernization of the Polish tractor and diesel engine industries focusing on the extension of the "Ursus" group of tractor factories based in Warsaw, by the introduction of tractors and engines based on MFP's technology. The production capacity of this group was to be expanded, over a fifteen year period, from the 1974 figure of 50,000 Ursus tractors per year to a potential for 75,000 Massey-Ferguson (MF) tractors per year, and approximately an additional 20,000 per year of Ursus tractors in a specific class. The MF tractors were to be powered by both three and four cylinder engines, and it was intended that 98 % of the parts used in these tractors would be produced in Poland. 6.3.2 The Details of the Agreement The main agreements covering this program were signed between the company and the Agromet- Motoimport FTO in 1974. The value of the Polish purchases of licences, associated technology and manufacturing equipment has been estimated at some 127 million at 1974 prices, it formed the largest single trade and industrial cooperation agreement between a British company and an EEC at the time. The deal was to be completely self-finanacing from the Polish foreign currency view point, as MFP agreed to 122 purchase some £165 million of Polish -made products. Some of these products could be sold by the company through its distribution network, and some could be used in its own factories. Other purchases include unrelated items from other Polish factories. Later in 1979 due to Western inflation in general, and British inflation in particular, MFP agreed to increase its counterpurchase to compensate for inflation and to avoid as a result any delay in the project due to postponment in the Polish purchases. The British company was responsible for the provision of all necessary technical assistance ranging from complete technical documentation for material specifications to quality and production control systems. The provision of training by the company has also been extensive, with teams of personnel from the Polish partner being trained at MFP's training centers. In addition, MFP had a team of engineers located in Poland to assist their Polish partners during the implementation phases of the agreement. 6.3.3 Motives of the Agreement MFP entered the agreement for a number of reasons, mostly related to the expansion, protection and diversifi cation of market opportunities through the exploitation of the licence, and the use of the licence to provide further business contact with Poland. 123 In the first place, it was apparent in the early 1970s that Poland wished to modernize its agricultural engineering industry, and was looking for Western assistance in this task. Since MFP had already identified Poland and other EECs as growth markets for agricultural engineering products, it wished to establish a protected position in that market. The role of supplier of products, components and technology seemed to be the best means of entry into the market in view of foreign currency restrictions on the purchase of finished products. Second, the company could see that an acceptable volume of income could be obtained from this venture through the initial sale of the license, and subsequent sale of c.k.d. tractors and components. Third, the company realized that it could expand its international market opportunities on a competitive basis by having access to another supply source where no direct capital investment was required. Further more, the competitive strength of this source became more apparent for certain of those products which were being produced in Poland in high volumes, and could consequently replace other uneconomic low-volume supply sources. The Polish partner's motives for entering the agreement stem not only from its need to modernize its agricultural production to become self sufficient in food but also from the attractive offer by MFP. The British 124 company offered to modernise Poland's product range of agricultural equipment, expand the volume of tractor output and establish its agricultural engineering industry on a modern technological footing. MFP's competitive position rested on a proven and reliable design of product. Furthermore, it was prepared to purchase Poland-produced items to balance the foreign currency expenditures of its partner. Comments a. The first thing to note is the "offensive" attitude of MFP towards countertrade. It used countertrade, in this case counterpurchase, as a tool to achieve its original goal of expansion, protection and diversification of its market opportunities through the exploitation of the licensing agreement with Poland. b. The counterpurchase agreement to finance the original project was one of the main reasons for the Polish government to get involved with this company in the first place. Another important reason for success in this industrial cooperation was the clear understanding on the part of the British company of the needs of the Polish partner. c. As for the spin-off benefits of this countertrade agreement, there is no information available on the benefits achieved by MFP itself in Poland or in EECs in 125 general. The project, however, has achieved considerable benefits for other British companies. The manifestation of goodwill on the part of MFP encouraged the Polish partner to sign two additional agreements with other British companies. The first agreement involved one of the major suppliers of parts to MFP in the UK. The company was recommended by MFP for its potential role as a major technology supplier for the Ursus group of factories. The second agreement was with a large British company specialized in the production and marketing of electrical, braking and fuel injection equipment for the automotive and aerospace industries. Though involving a different line of goods, the latter agreement taking place in 1979 was said to stem from various trade arrangements with Poland, particularly the one presented above. Last, but no least, following the signing of the industrial cooperation agreement between MFP and its Polish partner in late 1974, there was a significant increase in the market share held by Britsh companies for machine tools exported to Poland. During the period from 1975 to 1979, British exports of machine tools to Poland totalled some $133.4 million, accounting for 18% of Polish imports of machine tools from the major Western countries during those years, and for some 9% of total world exports of British machine tools ( $1,761.1 million). These exports compared 126 extremely favorably with British machine tool exports to Poland and the market share of Polish imports of Western machine tools during the 1972 to 1974 period (8%), and also the British market share of total world exports of Western machine tools between 1975 and 1979 (9%). d. Finally, besides the fact that this agreement provides a good example for the case of an "offensive" firm with clear positive outcomes as a result of successful use of countertrade, it is important in two other respects: first, it provides the details of a countertrade agreement and its repercussions on the relationship between the company and its export market which is valuable information seldom found in the literature. Second, it presents the experience of a European firm on which there isn't much information in the U.S.. 127 128 Figure 6-1. A Typical International Marketing Strategy by a Western Company. Analviia and Plannino Corporate Values Market Information Multisource currant 1. Evaluation of foreign market opportunities; 1. Company's export policies and guidelines commercial intelli gence f l o w t •election of target markets 2. Available human and capital resources X Product and techno logy characteristics Z Setting product and market objectives (e.g., product com parison and desired mix, market share size, handling of competition) X Selection of entry modes and strategies by techniques (e.g., exports, licensing, leasing, investment, CAs) and by person *1 1 1 H I nel (e.g., agents) Monitoring and adjust 4. Design of marketing ments program by country (e.g., channels of distribution, pro motion, pricing, financing) and by product l 4-' t 1 1 | > 1 1 Implementation of plan in target export market 1 Source: (Verzariu, 1985) p.83 Figure 6-2. The Decision Making Tree for a Defensive Firm. THE DECISION MAKING TREE FOR DEFENSIVE FIRMS are CA's an import requirement in this market? accept countertrade demands and think of how to get rid of the counterdel'ieries avoid this transaction do we want to get involved? avoid CA markets and transactions stick to our traditional export operations are CA's (countertrade) becoming a trend in our traditional export markets? 8onrce: Retrieved from (Verzeria, 1985) p.87 129 Table 6-1. M otivations Resulting In Long-Ttenn Com pensate]? A nangem ents Motivations Developlng-Country Importer Western Exporter • Best-Suited Projects Tb obtain foreign technology know how. management, marketing expertise and capital and by virtue ot the long term relationship, to assure that such tech nology is kept current and responsive to world market de mands lb develop and pro mote loint research activities lb maximize return on past research and development invest ments. especially when technologies are becoming obso lescent and subject to constant improve ments lb increase the amount of control over the partners marketing or produc tion activities, so as to protect own invest ment Projects requiring substantial fixed capi tal investment or ad vanced technology which is unavailable locally and which is considered vital lor the importing coun try's economic devel opment lb improve the coun try's trade position by import substitution, export stimulation and diversification To tullill industrial and consumer needs which are growing at a rapid rate lb take advantage of local availability of unused factory ca pacity. raw materials, and stable and inex pensive labor lorce lb assure a share in the local market growth and to ac quire a competitive edge on other firms operating in the same geographic region Projects for the manu facture of goods that tullill domestic coun try market needs in the developing country lb gain access to the marketing networks ot the foreign partner, develop collabora tion in third markets, and acquire or im prove marketing skills To reduce transporta tion or production costs lor exports To penetrate third markets through the developing country's regional or bilateral trade arrangements Export-oriented proj ects that upgrade lo cal goods or raw materials and pro vide the developing country with a posi tive foreign exchange balance Source: <Verzariu, 1985) p.68 130 CHAPTER 7 WELFARE IMPLICATIONS OF COUNTERTRADE MODEL I In chapters 4 through 6, we have been exposed to the practical experience of both individual countries, Egypt and Romania, and Western companies with countertrade. We have noticed the attraction of LDCs and EECs alike to countertrade. We have discussed some of the problems associated with commercial compensation as well as the potential benefits of countertrade in the form of industrial compensation for LDCs, EECs and MNEs. We have also raised a few questions as to how the pricing system used in the countertrade agreements could affect the welfare implications of these agreements for the different parties involved. The purpose of this chapter and the following ones is to pick up where the case studies left off and investigate some of these issues. While unable to answer all the questions raised, the countertrade model to be presented below is able to treat several aspects of countertrade which may be of use to both LDCs and MNEs in making decisions on whether or not to engage in countertrade. Some of these aspects were not even addressed in the previous chapters because of the limited information available on countertrade. 131 A very simple case of industrial compensation is the focus of the analysis, commerical compensation is also analyzed but rather briefly. The welfare effects of countertrade are compared to DFI and licensing to get a proper feedback for its significance. Two main questions are raised: first, what is the effect of a countertrade project (licensing with payment in resultant products) on the welfare of an LDC when compared to a regular licensing agreement and DFI? Second, how attractive is the countertrade option for a MNE when compared to a regular licensing agreement and DFI? The starting point of the analysis is the simple model of Bardhan (1982) where the welfare effects of a licensing agreement and a subsidiary on an LDC are compared. Several modifications in Bardhan's model, however, are necessary to consider countertrade as a third alternative. The results of the amended model are used to evaluate the performance of countertrade under various assumptions. A combination of analytic and simulation techniques is used. This chapter is organized as follows: section one presents the basic model of Bardhan (1982). Section two includes the countertrade model and its conclusions as far as the welfare of LDCs is concerned. We refer to the 132 countertrade model in this chapter as "model I" because a second version is introduced in chapter 8 in order to capture some additional aspects of countertrade. 7.1 Comparative Welfare Effects of Licensing and DFI on LDCs 7.1.1 Introduction and Basic Assumptions The purpose of the model is to focus theoretical attention on a specific problem of choice in technology to be obtained from MNEs and to apply partial equilibrium analysis of a kind familiar in the IO literature on vertical integration. Suppose an LDC has the choice of: (i) producing cars at home in a domestic firm licensing the technology from a MNE, which also involves buying the necessary intermediate goods, equipment and parts (all combined under the name components) from that enterprise- the familiar case of licensing with tied purchase of inputs, tied either by restrictive contracts or by the specificity of the licensed technology or (ii) producing them at home in a subsidiary of a MNE- DFI. Alternatives (i) and (ii) are denoted L and S respectively in the subsequent analysis. In the case of S, the import of components involves intrafirm trade, whereas in the case of L it is interfirm. This difference 133 has important implications in the analysis. The desirability of each alternative is evaluated in terms of total national welfare. In the case of S this is the amount of consumer surplus generated in the domestic market for cars, whereas in the case of L it is this consumer surplus plus the profits for the domestic firm. For simplification, there is no tax or tariff revenue and all profits of the wholly owned subsidiary in the case of S are remitted abroad. In the case of L, license fees or royalties are ignored since with the tied purchase of components the price charged for the latter provides enough leverage for the transnational company. Finally, the market structure is assumed to be symmetric. That is, in the case of domestic production under S the size of the domestic market is such that it allows the subsidiary of only one transnational company to cater to this market; similarly in the case of L the licensing firm has a monopoly in the domestic car market. 7.1.2 The Basic Model Suppose the domestic market for cars is characterized by the following constant-elasticity demand function:• Q-P -n ,T)> 1 (7-1) 134 where Q is the amount demanded, P is the price, and 1 7 is the (positively defined) price elasticity of demand. If Qs and Ql are the equilibrium quantities of cars produced under S and L, respectively, the expressions for total national benefit, our criterion of choice, are: where Bs is the consumer surplus at quantity Qs under S; Bl is the consumer surplus plus producer profits at quantity Ql under L; and C(Ql) is the cost function associated with production under L. No part of producer profits under S enters the expression for national benefit, since all of it is assumed to be remitted abroad. We shall assume that car components, m, are produced abroad by the MNE at a fixed per-unit cost f c . Imported components m and domestic labor 1 are combined in fixed proportions to produce cars at home, so that (7-2) ^ fQQlp(Q)dQ -C{QL) (7-3) 135 (7-4) The domestic market equilibrium for Q, characterized by marginal cost equal to marginal revenue, will yield , from equation (7-1), where is marginal cost for regime i. Now, under S, the subsidiary of the MNE maximizes P{Qs)Qs-<v L-km subject to equation (7-4) , paying domestic labor at the local wage ct>. The cost function in this case is: Computing marginal cost ,MS, from equation (7-6) and output Qs from equation (7-5), equation (7-2) may be rewritten as C s(Q s;fc,co) = (co + A:)Q (7-6) (7-7) 136 let us now take the alternative regime L. If is the price charged per unit of car components by the MNE, the cost function of the licensing domestic firm is: C1(Q£;q,>a>) = (a) + gI)Qi (7-8) Computing marginal cost Ml and putting it into equation (7-5), one gets Qi(qi). The demand for car components, 10(<3l) t can be computed by using Shephard's lemma, so that The MNE which is the licensor, will utilize the monopoly power (derived from the tied purchase of components by the licensee) to fix qi at a level which maximizes the former's profit from the sale of components, that is (qi“k)m(q]J . By solving the first-order condition, we get: Rewriting equation (7-3) using equations (7-5), (7-8) and (7-10) we get: 137 (7-11) Having derived the expressions for total national benefit under S and L in equations (7-7) and (7-11), respectively, in terms of the parameters n, w and k, let us now compare the two regimes : In his paper, Bardhan proves that "f (n)n is less than unity for all values of 77> 1 / implying that, under the conditions stated, DFI would contribute more to the national welfare of the host country than a domestic firm licensing the technology (with tied input purchases) from the MNE. This is despite the fact that the profits of the domestic firm are added to consumer surplus for evaluating the national benefit under licensing, but the subsidiary's profits are not so counted. The primary reason behind this result is that the distortion caused by monopoly pricing of intermediate goods for downstream producers is avoided by vertical integration by the MNE. So the subsidiary will market cars at a lower price (which generates more consumer surplus) than the licensing domestic firm. (7-12) 138 7.2 The Effects of Countertrade. Licensing and DFI on LDC Welfare 7.2.1 The Introduction of Countertrade into the Basic Model The main contribution of the first version of the countertrade model to be explained in this section, is to introduce the new alternative LC into the basic model explained in subsection 7.1.2. LC stands for licensing with payment in resultant products or more simply licensing with countertrade. It is one of several deals that fit into the large category of industrial compensation. Industrial compensation involves the sale of technolo gy, or plant with a contractual commitment on the part of the seller to purchase a certain quantity of products that are produced by or derived from the original sale. Other than being the fastest growing form of countertrade, industrial compensation is interesting in still another way. Unlike commercial compensation, where the counterpur chased goods are not related to the original sale and often hard to dispose of by the DCs, the goods counterpurchased by the DCs under industrial compensation are the products of their own plants or technologies but may be cheaper since, because they may be produced in LDCs or EECs are likely to have lower labor costs. This means that it is 139 actually in the interest of the DCs to increase and not decrease the amounts of final products they buy back because they will either use it in their own lines of production, which would mean a cheaper input than if it were produced at home, or sell it in the international market for a profit. The procedure followed in analyzing "countertrade model I" is to repeat the same calculations as in the basic model for alternative LC in the modified model, and then to compare the benefits to the LDC associated with the three alternatives. We also note that the basic assumptions of the previous model concerning market structure, choice of production function, demand function and the measure of welfare remain the same for the countertrade model. Finally, the economic pressures that led to the existence of countertrade and the barriers to free trade that plague the international trade environment, as we explained in detail in chapter 2, constitute the general context in which we are studying countertrade in this chapter and the ones to follow. 7.2.2 The Countertrade Model (Model I) The introduction of the new regime LC into the basic 140 model adds the following: a. The essence of countertrade is that the payment for components takes the form of final output: <72™(<?2) = Pz-CT (7-13) Where q2m(q2) is the total value of intermediary components imported by the LDC, q2 being the new price of components to be decided upon by the licensor (MNE) in the same manner as in a regular licensing agreement. CT is the amount of final output, here cars, that the MNE has to purchase from the LDC at a price P2 per unit so that the equality in equation (7-13) holds. In this version of the model "P2« ' is chosen to be equal to "P" the domestic price for cars which implies that equation (7-13) can be rewritten as: where Qlc is the total, amount of production under LC. We note that equations (7-13, 14) imply that the payment for intermediary components by the LDC is made fully in terms of the final output which is typically the case in industrial compensation. b. The expression for the total national welfare of the LDC under countertrade is still consumer surplus plus <7 2m{q2) = P{QLC).CT (7-14) 141 producer's profit. However, since the quantity sold in the domestic market under countertrade is less than the total amount of production QLC, both consumer and producer surpluses have to account for this change. The total national benefit under LC, is given by the expression: c. Given the above description of the nature of industrial compensation deals, the MNE now has another motive besides maximizing its profits on the sale of intermediary components to the LDC, namely maximizing its profits from selling CT in the international market. Mathematically, the licensor's decision-making problem is changed to: where P^ is the price at which the MNE sells CT in the international market and (P^ - P2) represents the profit gained by the MNE on each unit of CT. In this version of the model Pi is assumed to be equal to yP w h e r e y > i ,i.e., P ^ is defined to be a price higher r v lc ~ 01 / P(Q)dQ -co(q£C) Jo (7- 15) max{{q2 - k)m{q2) + {P x - P 2)CT) (7- 16) 142 than the domestic market at which the MNE buys CT from the LDC (result #4 discusses the other values that y can take) . The expression in equation (7-16) can then be written as: max{{q2-k)m{q2) + {yP-P^.CT} (7-17) Substituting for CT from equation (7-14) and solving for the first order condition of the maximization problem in equation (7-17), we get: where q2 is the unique feasible solution of the maximization. Using equation (7-18) we now solve for Qlc and Blc : 772(coy + /:) ~q (7- 19) (7-20) 143 If we move on to evaluating the performance of all three regimes L,S and LC by comparing the expressions in equations (7-7), (7-10), (7-11), (7-18) and (7-20), we reach the following results: Result #1 The price of components under LC, q2, is less than q-L the price of components under L in the basic model. Proof: 32 < 3l and only if (yco+r7fc) (a> + r7fc) y(*7~ 1 ) < (>7“ 1 ) if we multiply both sides by y (r?-i) we get: (yco + T]k') < y(co + rjk} if we subtract y t o from both sides, we end up with: rjk < y r j k which is true at all times because y>i which implies that 32 < 3l f°r values of v, y, c o and f c . As shown in figure 7-1 there is a significant difference between qi and q2 for 144 all values of n. The introduction of countertrade has helped reduce the distortion caused by monopoly pricing of intermediate goods for downstream producers. This result, although important for its own merit, is significant in still another way, it reflects a change in the attitude of the MNE towards the LDC. Under countertrade, just as under regular licensing, the MNE maintains a monopoly power to decide upon the price of the intermediate components sold to the LDC. What is different about countertrade, however, is that the incentive of the MNE to charge the highest price possible to the LDC is changed. Countertrade creates another source of profit for the MNE besides the intermediary components. This new source of profit is the sale of the countertraded goods in the international market. Since the MNE purchases the countertraded goods, in this case cars, from the LDC, it is no longer in its best interest to charge the highest price possible for the intermediary components because this will be reflected in the price the MNE has to pay for the final output thus reducing its profit when selling it. This new interest of the MNE in the final output produced by the LDC or, to be more specific, the explicit linking of the import of components 145 to the export of the final output by making the payment for the components in terms of cars, alters the incentives of the MNE in such a way as to benefit the LDC. The lower price of components under countertrade also reflects more efficiency in production because it means a reduction in the distortion caused by monopoly pricing by the MNE under regular licensing. A lower price of components lowers cost, raises output, lowers the price for consumers and a raises consumer surplus. All these changes mean more efficiency. Finally we note that, although a lot of attention in this section as well as the ones to follow will be focused on the price of components, we have to bear in mind the above interpretation as our main concern. Result#2 BLC or tlie national benefit under LC is higher than Bl the national benefit under L ,i.e., LC contributes more to the national benefit of the LDC than L. This conclusion was reached by calculating the ratio of Blc to BL from equations (7-20) and (7-11) and proving that it is greater than 1. Since it is analytically cumbersome to perform the latter task, computer simulation was used. The ratio bLc/bl was computed over different ranges of the various 146 parameters: y ” (1 .05,1 .1 ,1.15), r j « (2,3 , . . 16), to “10 and fc-20l. In figure (7-2), we can see that Blc/Bl increases as n increases, i.e., the more competitive the domestic market the more superior the countertrade alternative is to a regular licensing agreement. From table (7-1) we also note that Blc/Bl increases as y increases i.e. the more profit achieved by the MNE per unit of counterpurchased goods, the better the countertrade alternative for the LDC. If we look at diagram "a" of consumer and producer's surplus under L and LC, we can see more clearly how the LC alternative is more beneficial to the LDC than a regular licensing agreement. If we compare areas "abed" or the consumer surplus+ producer's profits under L to area "ebfg - QCTghQLC" which is the national welfare of the LDC as in BLC (equation 7-15) where "oehQLC" is (a/.QLC) or the total labor cost of production. The superiority of countertrade over licensing indicated by the simulation results implies that "ebfg - QCTghQLC" is larger than "abed" even though less than the total amount produced is being consumed at home under the former arrangement. From diagram "a", this means a gain in both consumer and producer surpluses. If CT is larger than 1 Significant values were only found for 77-(2, u). The range of 1}, however, is still quite reasonable because while the elasticity of demand could in principle rise to infinity, in practice an elasticity of 10 would seem to be a reasonable upper limit. 147 the difference between QL and QLC, there will be a loss in consumer surplus that is overcompensated by the gain in producer's profit. The main reason behind the superiority of LC is a lower marginal cost (MLC) which implies a larger output and a lower domestic price for the consumers. Both of these result in a larger national welfare despite the fact that less than the total amount produced is being consumed locally. As y increases, q2 decreases which means an even lower marginal cost and as a result an even higher output i.e. more additional welfare under LC. As n increases there is a shift to the new demand curve where Si• S2' Qlc/ Ql, pL» and PLC are at lower levels than before. As a result both Blc and BL decrease. Blc remains, however, larger than Bl for each level of n and as i ) increases Bl decreases faster than Blc so ratio BLc/BL becomes larger and larger than 1. Result#3 Computer simulation over the same range of parameters was also used to determine how countertrade compares to the case of DFI. Blc/bs was computed and compared to 1. It was found that Blc/bs is also greater than 1 for most values of n. Blc/bs also increases as n and y increase (figure 7-2 and table 7-1 above). We conclude then that LC 148 or countertrade is not only superior to a regular licensing agreement, but is also superior to DFI for most values of r ? How can we interpret these results? If we look at diagram "b", we note that when we compare Blc Bs what we are really comparing is area Mebfg - QCTghQLC" ( the LDC's welfare under LC) to "abi" ( the LDC's welfare under S). Which one of the two is larger depends on whether "fxi" or "eaxg - QCTghQLC" is larger. The former area represents the additional consumer surplus associated with S due to the very low value of MS( marginal cost). The latter, on the other hand, represents the gain in producer's profit associated with the LC alternative. According to our results, regime S is superior to regime LC in terms of the LDC's welfare for n<8 This means that "fxi" > "eaxg - QCTghQLC" for these values of n. As n increases, however, the gain in producer's profits overcompensates for the loss in consumer surplus ("eaxg"-(QCTghQLC">"fxi")) and the LC alternative becomes superior, i.e. Blc/bs> - 1 -* Finally, we note that just like in result #2 above, the superiority of LC is reinforced by the increase in y. Result #4 So far we've been looking at the situation when y>i which implies that > P2 . What we consider here are the 149 two other possibilities, o<y«i. When o<y<i, Pi < P2 which means that the MNE makes losses on the countertraded goods. It sells them at a price lower than the one at which it has bought them. When y-i, on the other hand, Pi = P2 which is a situation of 0 profit but at the same time 0 loss for the MNE. These two cases are important because they shed some light on the case of commercial compensation where the disposal of the countertraded goods is always a problem for the MNE. As shown in (figure 7-3) the price of components under LC/ <32/ larger than its counterpart under L, q^, for o < y < l. The primary reason behind this result is the loss the MNE makes on the countertraded goods because Pi < P2. To compensate for its loss, the MNE charges the LDC a higher price for the intermediary components. When y =l, on the other hand, q2=ql which means that the countertrade option gives the same results as regular licensing. Since the MNE makes no profit on the countertraded goods, its only concern is the maximization of the profit it makes on the intermediary components which is the same situation as in a regular licensing agreement. The relationship between Blc, Bl and Bs also chahges as y changes its value. As shown in figure 7-4, Blc/bL < 1 for o < y« l which means that countertrade contributes less to the welfare of the LDC than regular licensing does. This 150 results follows directly from the fact that for o<y<i, the price of components under LC is higher than under L. The higher price of components leads to higher costs, less output and less welfare for the LDC. When the price of components is equal under countertrade and licensing, countertrade still contributes less to the national benefit of the LDC than regular licensing because less than the total output is being consumed at home. As for the comparison between DFI and countertrade, the former alternative was found to be superior to the latter in its contribution to the national benefit of the LDC for o<y«i. The high costs associated with countertrade make it a less efficient alternative for the LDC. An interesting point to note is how the national benefit of the LDC seems to be related to how successful the MNE is in disposing of the countertraded goods. When y<i and the MNE makes losses on the countertraded goods, LC is the most inferior option for the LDC as compared to the other two alternatives. On the other hand, when y>i and the MNE makes profits on the countertraded goods, LC is superior to the other two options. The potential profit, on the countertraded goods, that is associated with the LC option alters the incentives of the MNE towards a more efficient arrangement for the LDC. Concluding Remarks 151 In this chapter we explored the welfare implications of countertrade. Given the assumptions of the model, in the case of industrial compensation ( y> 1), countertrade proved to be superior to both regular licensing and DFI as far as the welfare of the LDC is concerned, in spite of the fact that less than the total output produced is being consumed at home. This result is particularly interesting because it qualifies the conclusions reached in Bardhan's 1982 paper. The mere addition of countertrade (payment for components in terms of final output) to a regular licensing agreement has the effect of boosting the modified licensing to a superior position to alternative S. The cases of o<y«i were also explored in this section to shed some light on commercial compensation the other major category of countertrade that is not the main issue here. Countertrade was found to be inferior to the other two alternatives in this case mostly due to the difficulty of disposing of the countertraded goods that is typical under commercial compensation. 152 Figure 7-1. Countertrade Model li The Relationship Between the Elasticity of Demand and Qi & Q». H U1 W w I - z HI z 0 u _ 0 HI g IT CL 4 0 2 5 ■ • a —- —{ ] 20 2 5 12 4 10 ELASTICITY OF DDvlAND O Ql + Q2 RATIO OF BENEFITS Figure 7-2. Countertrade Model Ii The Relationehip Between the Elaeticity of Demand and Blc/bl> Blc/bS 2,2 . a - " " 0 ,7 2 16 4 5 10 12 14 H ELAST1CITT OF DEMAND £ 0 BLC/B5 + BLC/BL Table 7-1. Relationship between BLC/BL, BLC/Bs and y V =8 y BLC/BL BLC/Bs 1.05 1.105 0.814 1.10 1.372 1.010 1.15 1.681 1.238 H U 1 in b t - - DEMAND , CURVE *a MR LC e 0 0 Q, Q Q LC Diagram a H c r M b i- - DEMAND CURVE a * uC MR e 0 Q Q CT LC Q 0 Q CT Diagram “b v r Cl AND Figure 7-3 . Countertrade Model Is The Relationship Between Ql and Q2 and y. 53 -T- 29 - 27 - 26 - 24 - 1,05 0 .9 5 y o Ql + Q2 H 0 1 OP RATIO OF BENEFITS Figure 7-4. Countertrade Model I: The Relationship Between the Ratio of Benefits and Y. 0 .7 - 0.6 ~ 0 .5 - 0 .4 - 0.2 - 1.15 1.05 0 .7 5 □ BLC/B5 + BLC/BL CHAPTER 8 WELFARE IMPLICATIONS OF COUNTERTRADE MODEL II The main purpose of this chapter is to introduce a second version of the model in chapter 7. It will be referred to as ’ 'countertrade model II". The main reason behind introducing the second version of the model is to focus attention on some additional aspects of countertrade. Some of the assumptions of the first version of the model are changed for that purpose. Sections 8.1 and 8.2 are confined to the analysis of model II while the remaining two sections analyze the results obtained when the market structure is changed from monopoly to duopoly and when the production function is changed from one of fixed proportions to that of Cobb-Douglas. 8.1 The Differences Between Models 1 and II First, in equation (7-14) which describes the payment for components in terms of final output, the price P2 , that the LDC charges the MNE for the counterpurchased goods CT, was assumed to be equal to the domestic price P. In this version of the model, however, P2 will be changed from the 160 domestic price P to the marginal cost of production. Given the production function as specified in equation (7-4) above, we get: P2 = (co + q2) (8-1) There are two main reasons for the respecification of P2 = (a) To investigate how changes in P2. affect LDC welfare. The importance of this issue stems from the general lack of information on the pricing system used in various countertrade agreements that we noticed in the case studies above and that makes an appropriate evaluation of these agreements rather difficult. P2 can range between a minimum, namely the marginal cost of production, and a maximum, namely the domestic price which can very well be larger than the international price if the domestic market is monopolistic in structure. We chose P2. such as it is equal to its minimum possible value so as to analyze the the worst situation possible for the LDC. (b) To expand the countertrade model in a way that enables us to study another aspect of countertrade. In "countertrade model I" the emphasis was on introducing the unconventional barter aspect of countertrade, payment for 161 components in terms of final output, without paying too much attention to the details of what P2 really is. "Countertrade model II", on the other hand, attempts to capture both aspects at the same time. Second, the final change in this modified version of the model is that P^ in (7-16), the price at which the MNE sells CT in the international market, is changed from P in (7-17) to: i.e., Pi is equal to the domestic price. The main reason behind this change is mathematical simplification along with more realism in assigning a value for P^ especially after the change in P2 that was described above. 8.2 Countertrade Model II Substituting for P2 and P^ from equations (8-1) and (8-2) respectively, the maximization problem in equation (7-16) now becomes: P^P{Q lc) (8-2) max{(q2-fc)m(q2) + [/*-(co + qa)]CT} (8-3) 162 Solving for the first order condition of this maximization after substituting for CT from equation (7-13), we get a new value for q, 2 - Where q2 is the unique feasible solution of the maximization. From q2, we solve for Qlc and Bl^: We note that Bl<^ which is specified as in equation (7-15), is not simplified further to maintain a manageable expression. If we are to substitute for Qlc in this expression, we would get Bj^ q as functions of to, ,n and f c . Having obtained values for q2, Qlc* bLC and knowing Bs and Bl from equations (7-7) and (7-11), we now move on to the comparison of the three regimes (LC,L and S) in the same procedure followed in chapter 7. (8-5) (8-6) 163 As in chapter 7, a combination of analytic and simulation techniques were used to reach the results below. The conclusions from comparison of q2 to q^ were reached analytically (result #1). As for results #2 and #3, Blc/Bs and Blc/bl were computed over the following range of parameters 1 7 — ( 2 , 16) . c o - 1 0 , and f c - 2 0 , where u> is the local wage rate and k is the per-unit cost for the imported components m. Result #1 As shown in figure 8-1, the price of components under LC (^2) less than that under L (ql) in spite of the change in P2 . Proof: _ _ [a) + k(T]- 1 ) ] ^ (CO + 77A:) q*<q\ & — 7— rr— < (77- 1 ) (77- 1 ) If w e m u l t i p l y b o t h s id e s b y ( 77- 1 ) , w e g e t : go + £(77 - 1 ) < go + T)k S u b t r a c t i n g (co + ^fc) f r o m b o th s id e s , w e g e t : -k <0 164 which is true at all times. This implies that: <72 <<7 1 for all values of 17. 00 and f c This result reinforces the notion that the introduc tion of countertrade reduces the exploitation motives of the MNE as explained in chapter 7 above. The lower price of components under countertrade also reflects more efficiency in production because a lower cost means a larger output and a lower price for consumers. Whether this larger output and a lower price will lead to a larger consumer surplus can only be known after calculating BLC and comparing it to BL and BS. Result #2 If we start by comparing countertrade to licensing, we note that at large values of n countertrade is equivalent to regular licensing. For small values of 1 7 however, Blc/Bl <1 which means that as far as the welfare of the LDC is concerned countertrade is inferior to regular licensing (figure 8-2). BLC/BS turned out to be smaller than 1'for all values of n, indicating that countertrade is inferior to DFI. We can then conclude that the low price charged by LDC for its countertraded goods is not neutral in its 165 effect on the LDC but rather has a significant effect on its welfare as it tends to reduce the LDC's consumer and producer surpluses. The change in the specification of P2 has two effects: 1) it reduces the producer's profit by (P-P2).CT which is the profit the producer could have made had he sold CT in the domestic market or had he charged the domestic price P to the MNE; 2) it also tends to increase CT which means that an even smaller amount is being consumed in the domestic market. A loss in consumer surplus is always expected under countertrade because less is consumed domestically. What is different here however, is that after the change in P2, the producer's profit does not increase enough so as to compensate for the loss in consumer surplus which leads to a low BLC., orte that is lower than and Bg. under the given assumptions of the model. As explained in chapter 7, an increase in n implies a new demand curve along with lower PL, PLC, PS, Qlo Ql/ Qs and as a result lower Bs,Bl and B^c. The decrease in BLC, however, is smaller than that in Bl which leads to a larger ratio as stated above. Bi,c/Bg remains unchanged as n ' increases, indicating that they both change at the same rate. 166 The purpose of the following sections is to change some of the other assumptions of the model, in particular the market structure and the production function, to see if such changes would alter the results reached in this section. In other words, what we want to know is whether such changes will reduce or increase the negative effect caused by the change in P2 and how this would, in turn, affect the performance of countertrade relative to the other two alternatives. 8.3 Duopolistic Market Structure In the previous sections as well as in the previous chapter, we've been holding on to the assumption that the domestic market structure was monopolistic in nature. This means that in the case of domestic production under S, the home market size is such that it allows the subsidiary of only one MNE to cater to this market. Similarly, in the case of L and LC, the licensing firm has a monopoly in the domestic car market. In this section, however, we'll relax this assumption and instead assume Cournot-Nash duopoly all around. In other words, we now assume that in the case of S, subsidiaries of two MNE companies produce and compete in the domestic market. In the case of L and LC, there are two licensing firms catering to the domestic market. They both buy components, however, from a single licensor or MNE 167 in the world market. Changing the market structure adds realism to the model by allowing for more than one firm to exist while maintaining the simplicity of the model by using the Cournot-Nash arrangement. Due to similarities in the procedure followed, we'll present here only the main changes from previous sections. If we first consider the S alternative, using profit maximization under Cournot-Nash duopoly assumptions from each subsidiary, we get: Bs=au-iy (2/7-1) _ 2 / 7 ( co + fc) (8-7) Under L, we have two domestic firms producing cars and buying components from one foreign monopolist. We first work out the reaction function of each domestic duopolist which then gives us the demand for components from the MNE to which they are both tied. This in turn helps us solve the maximization problem to get a value for and solve for Bl : Bl = ~ ( - 2/7 - 1 ) (77 - 1) ” I J - 1 3/7 - 1 2772(o/ + fc) L 2 77 (77 — 1) J (8-8) 168 q^ turned out to have the same value as in equation (7-10). If we follow the same procedure above to solve for the LC alternative using P^ and P2 as specified in equation (8-2) and equation (8-1) we get: Having obtained values for Bs, Bl o we proceed to the comparison of regimes as we did in section 8.2. A combination of analytic and simulation techniques is used. Result #1 As shown in figure 8-3 the hypothesis that the price of components under LC is lower than that under L i.e. that countertrade is superior to a licensing agreement in the sense that it reduces the exploitative power of the licensor, is reinforced. Output under countertrade is also larger that its counterpart under regular licensing. Result #2 (8-9) i j - 1 (8- 10) 169 Computing BLC/Bg and Blc/Bl and comparing the results to 1, we reach the conclusion that countertrade remains inferior to DFI and regular licensing (8-4). The change in the market structure did not alter the result reached under a monopolistic market strucutre. The reasons for the inferiority of countertrade closely follow those presented in the previous section. The sale of the countertraded goods to the MNE at P2 < domestic price causes a loss in producer's profit that is added to the loss in consumer surplus associated with the consumption of less than the full output domestically. Given that everything else in the model remains unchanged, this raises the question as to what extent and how the duopoly market structure differs from that of monopoly. Finally, we note that the increase in n does not affect the result reached above as BL, BS and BLC tend to decrease at the same rate resulting in rather constant ratios. Result #3 If we compare the performance of countertrade under the monopolistic market structure to that under the duopolistic one in terms of national welfare under LC-, we note that the value for national welfare under countertrade bLC is approximately equal under the two market structures. While this result is surprising in the sense that a duopoly market structure by definition implies a larger output and lower domestic prices, it is not surprising if we note that the price of components (q2> under duopoly is higher than the one under monopoly (figure 8-5). A higher q2 implies a higher marginal cost and a lower total output which sort of wipes out the increase in output associated with duopoly. So a low q2 and a monopoly market structure achieved the same level of welfare for the LDC as a higher q2 and a duopoly market structure. 8.4 Cobb -Doucf 1 as Production Function In the industrial organization literature on vertical integration, it is well known ( see, e.g. Schmalensee, 1973; Warren-Boulton, 1974) that welfare effects can be quite different between the case of fixed factor proportions and that of variable proportions in the downstream production process. Accordingly, we take the simplest case of variable proportions, Cobb-Douglas functions, in car production and investigate how the results above on the comparative evaluation of regimes S,L and LC change. We note that we go back to the case of monopoly in the domestic market that we started out with in chapter 7 and section 8.2 above. Equation (7-4), the production function, is now replaced by; 171 0 < a < 1 (8 - 11) Where a is the labor elasiticity of output in car production. If we start by considering the changes in regimes S and L due to the change in the production function, we note that equations (7-1), (7-5), (7-6) and (7-7) remain as before. Making the appropriate changes in equations (7-8)- (7-12), we obtain: Bs = n o ; a Jfc( 1 * a ) (1-0) aa( 1 -a) ( l - a ) ( 8 - 12 ) Qi - * ( 1 - a)(77- 1)^-1 (l-a)(77-l) (8- 13) B i = r/ (2^7-1) u>a.q\1"aJ (i-o) L (*7 - 1 )( 2 ', ? ) J _ a a ( 1 -a)(1'a)_ (8-14) As for the case of LC, the most important change occurs for the value of P2 in equation (8-1). It is no longer equal to (w + q2) but rather to the marginal cost associated with the new production function: B 2 M ic ooa.q^-a) a"(l -a) (1 -a) (8-15) 172 If we make the appropriate changes in the rest of the equations using the new P2 and following the same procedure as in the case of S and L, we get: [(l-axg-n+ij ? 7( 1 -a) (8-16) (JOa.q'2-a aa( 1 - a)(1-a) Q lc- C T ] (8-17) where LC rj -i? o>a . _ 1 - a <72 -1 1 . _ a ° ( 1 - (8 - 18) and CT = ( 1 ~ a) Q LC (8-19) Comparison of the regimes S and L was conducted in Bardhan (1982). He proved that for a<0.43, DFI is superior to regular licensing. Also very large values of n insure the S alternative to be superior irrespective of the value of a. in other words, for small values of the labor elasticity of final output or when the degree of monopoly 173 power in the domestic market is sufficiently low, the subsidiary of a MNE contributes to the national welfare of the host country more than a domestic firm licensing the technology from the MNE. If we compare LC to the other two regimes using simulation techniques over the ranges: > 7 = (2,16), a = ( 0. 1, 0. 2,..0.9), w = i o and k - 2 0, we get the following results: Result #1 The price of intermediary components under LC {q. 2 ) is lower than its counterpart (q^ for a regular licensing agreement L. This implies that the change in production function did not affect our previous conclusion that countertrade reduces the exploitative power of the licensor. We also note that both q^ and q2 decrease as n increases (figure 8-6). They tend to increase, however, as a increases given n ( figure 8-7). The lower price of components means a lower cost and a larger output for the LDC under countertrade than under regular licensing. Result #2 The parameters i j and a play an important role in the comparison of LC to L and S. If we first compare countertrade to regular licensing via computer simulation, we note that given a, blc/bL >1 which means that countertrade is superior to regular licensing for all levels of n, (figure 8-8) . If we hold n constant and 174 change a we note that countertrade remains superior for most values of a (a>.25), (figure 8-9). These results mean that the change in the price of CT, P2, does not reduce the national welfare of the LDC as in the case of the fixed proportions production function. In fact under the Cobb-Douglas production function, the welfare of the LDC under countertrade is even higher than that achieved by regular licensing making the former a better regime for the LDC. As for the comparison of countertrade to DFI, we note that given n, Bj^c/Bg >1 for <*>-6 i.e. countertrade is superior to DFI for large values of the labor elasiticity of output (figure 8-9). This result holds typically in the case of sufficiently low levels of n (figure 8-10) . In other words, for large values of the labor elasticity of final output and when the degree of monopoly power in the domestic market is high, countertrade contributes more to the national welfare of the LDC than DFI. As n increases BLC/BS tends to decrease meaning that DFI becomes increasingly superior for the welfare of the LDC. The main reason behind the fact that an increase in the labor elasticity of output tends to boost countertrade over the other two available choices is that from equation (8-19), which gives us the value of CT as a proportion of QLC, a high a implies a lower CT i.e. a smaller portion of 175 the final output to be consumed abroad as opposed to being consumed in the domestic market. This in its turn means a smaller loss in the consumer surplus and also a smaller loss in the producer's profit as a result of P2. Concluding Remarks In this chapter we explored how the change in the price of CT, the countertraded goods, affects the welfare implications of countertrade as compared to regular licensing and DFI. It was found that when holding the market structure and production function assumptions of the previous chapter, countertrade turns out to be inferior to the other two alternatives as far as the welfare of the LDC is concerned except at high levels of elasticity of demand when it becomes equivalent to regular licensing. It is important to note however, that despite the inferiority of countertrade in terms of the welfare of the LDC, costs are lower and total output larger under countertrade than under regular licensing. This means that the efficiency of countertrade as far as production is concerned remains unchanged, what is changed is the division of this output between the domestic and international market and the prices involved. Some of the assumptions of the model have been relaxed to see whether the change would alter the conclusion reached above or more precisely whether a different market 176 structure or a different production function could reduce the damage caused by the low P2. The change in market structure from a monopolistic to a duopolistic one while holding on to the fixed proportions production function does not change the above result. A change in the production function from a fixed factor proportions production function to a variable proportions production function, Cobb-Douglas, however, has alters the result above so that countertrade becomes superior to regular "licensing and DFI with the latter result applying only for high levels of the labor elasticity of output and low levels of the elasticity of demand. Finally, we note that the results of this chapter indicate the importance of the price specification of the various commodities exchanged under countertrade, an issue often ignored by LDCs. A very low price for the commodities sold to the MNE in exchange for the components could render countertrade inferior to other forms of investment. The harm caused by the low P2 can be removed or reduced under specific conditions. Finally, it is important to note that, while the assumption that the national welfare of the LDC is equal to the consumer and producer surpluses is important in the sense that it focuses on how countertrade as well as the other forms of investment affect the consumers and producers in this 177 specific aspect, it ignores other effects that are often even more important for the LDC, such as the importance of promoting exports, adequate technology transfer and the importance of financing. A general evaluation of counter trade will have to take account of all those factors besides the ones considered in the model. 178 \ Figure 8-1. Countertrade Model II: The Relationship Between the Elasticity of Demand and 01 and 02, o ? o _J a : UJ a UJ i - z UJ z O CL s u . O UJ g a c a . 50 4 0 - 1 4 12 10 H V O ELASTICITY OF DEMAND □ Q 1 + Q2 RATIO OF BENEFITS Figure 8-2. Countertrade Model IIs The Relationship Between the Elasticity of Demand and Blc /Bs and Blc YBl. 0.5 - 0,7 - 15 14 12 0 H 00 o ELASTICITY OF DEMAND □ BLC/BS + BLC/BL PRICE OF COMPONENTS UNDER LC AND L A Figure 0-3. Duopoly Market Structuret The Relationship Between the Elasticity of Demand and Q1 and Q2. 60 40 30 - 2 4 6 1$ 3 10 14 12 00 ELASTICITY OF DEWAND H □ Q1 + Q2 RATIO OF BENEFITS Figure 8-4. Duopoly Market Structure: The Relationship Between the Elasticity of Demand, Blc/Bs, Blc/Bl and Bl/Bs 0.9 - 0.6 ~ 0.7 ~ 0.6 - 0.6 - 0.4 1 6 14 10 12 6 2 4 ELASTICITY OF DEMAND □ BLC/B5 + BLC/BL A BL/B5 H 00 to \ Figure 6-5. Comparison Between Monopoly and Duopoly: The Rela tionship Between the Elasticity of Demand and 021 and 022. o 3 O i d 6 z O 2 IT 111 a z 3 C / 1 I - z U J z 0 Q . 2 O a u _ O UJ o i r a. 40 1$ 14 10 12 H 00 U) O 022 DUOPOLY PRICES ELASTICITY OF DEMAND + 021 MONOPOLY PRICES Figure 6-6, Cobb-Douglas Production Function; The Relationship Between the Elasticity of Denand and 01 and Q2, <0 H- Z 1 1 1 z o 0. r o o u. o Ul o t-i QL Q l 50 - 40 - e -a B E l 20 16 14 12 10 6 6 4 2 H 00 ELASTICITY OF DEMAND □ Ql + Q2 Figure 8-7. Cobb-Douglas Production Function: The Relationship Between Labor elasticity of output and Ql and 02. , o i - - - - - - - - - 1 - 1 - - - - - - - - - i- - - - - - - - - 1 - - - - - - - - - 1 - - - - - - - - - 1 - - - - - - - - - 1 - - - - - - - - - 0.1 0,3 0,5 0.7 0.9 L*BQR ELASTICITY OF FINAL OUTPUT Q Ql + 02 H 09 ui Figure 8-8. Cobb-Doaglas Production Function; The Relationship Between the Elasticity o£ Demand and Blc/Bs and Blc/Bl. < n t u . t u z U i £ D U u o o t t . I ■£. 1,05 - 0,95 0.9 ~ 0.55 - 0,5 12 14 10 5 4 2 H 00 a ELASTICITY OF DEMAND BLC/BS + B LC/BL Figure 8-9. Cobb-Douglas Production Function: The Relationship Between Labor Plasticity of Output and Blc/Bs and Blc/Bl. 1 1 =2 0 .5 - 0 .7 - 0,6 “ 0 ,5 0 .3 0.7 0.9 0.1 LABOR ELASTICITY O f OUTPUT a BLC/BS + BLC/BL 0 0 Figure 8-10. Cobb-Douglas Production Function: The Relationship Between the Elasticity of Demand and Blc/Bs. i - i Z U J z UJ I D U . o o % 1,12 1,06 1,04 1.02 0 .9 5 16 6 5 10 12 14 2 4 ELASTICITY OF DEMAND □ BLC/B5 CHAPTER 9 COUNTERTRADE FROM THE MNE PERSPECTIVE AND THE EXISTENCE OF EQUILIBRIUM This chapter has two objectives: 1) to address the second main question raised in the theoretical portion of this study, namely the profitability of countertrade for the MNE under the different assumptions of the model and 2) to combine the LDC and the MNE into the same analytical framework to determine how their joint decision making takes place. The combined conclusions of the model are also included at the end of this chapter. 9.1 The Introduction of MNEs into Countertrade Models I and II In the previous two chapters the focus was on how the LDC is affected by countertrade. Shifting the attention to the MNE, however, is extremely important because it allows us to investigate the sweeping but unsubstantiated claim in the literature that Western companies are coerced into using countertrade resulting in financial losses. Assuming that the MNE has the option of choosing between countertrade, regular licensing and DFI, we compare 189 profits gained by the MNE in each one of these three cases. The alternative that generates larger profits for the MNE would clearly be the more attractive option. The evaluation of MNE profits is performed under four alternative scenarios: (1) a monopolistic market structure with a fixed coefficient production function and and P2 specified as in the model of section 8.2; (2) the same market structure and production function as (1) with P^ and P2 specified as in the model of section 7.2; (3) a duopolistic market structure along with the same production function as in the model of section 8.3; and (4) a monoplistic market structure with" the Cobb-Douglas production function as in the model of section 8.4. Whenever appropriate, a comparison is also made between profits associated with countertrade in the above four different cases. The profits of the MNE under regular licensing, countertrade and DFI are represented by L2 and L3 respectively. (9-1) L2 = (q2-k)m(q2) + (P } -P2).CT (9-2) 190 L3 = P .Qs-Cs{Qs;k,a)) ( 9 - 3 ) L3 is expressed as the producer's profit on the final output produced Qs. As explained in section two above, this profit does not go to the LDC, instead it is remitted abroad to the interest of the MNE. L2 consists of two parts, the first part represents the profit of the MNE on the sale of intermediary components to the LDC. The second part represents the profit it makes when selling CT in the international market. Lj_, on the other hand, is the expression for profits on the intermediary components. We finally note that L2 and L^ are the same basic expressions that we maximized above to get values for q2 and q^. 9.1.1 Case One: Monopolistic Market Structure and the Fixed Coefficient Production Function fmodel in section 8.2) We first start by comparing countertrade to regular licensing. Given the model as specified in section 8.2, we compute L2/L1, the ratio of profits achieved by the licensor (MNE) under LC to its counterpart under L, and compare what we get to 1 for various values of n. From computer simulation, we note that, given n, L2/L1 is considerably larger than 1 (figure 9-1). This means that 191 given any particular level of elasticity of demand in the domestic market, profits achieved by the MNE under countertrade are always much larger than those achieved by the same licensor under a regular licensing agreement. This in spite of the fact that we proved in section four that the price of intermediary components under LC is lower than that under L which means that the MNE makes less profit per unit of intermediary components under countertrade than under a regular licensing agreement. We finally note that as n increases L2 and tend to change at the same rate which leads to a constant ratio. How can we interpret those results? If we look at diagram "c" we note that the comparison between L2 and is really a comparison between the two functions 1*2 (q2) and Li(qi) on diagram. The two solid line represent the profit functions given a certain value of ? ? . 1*2 (<i2) reaches its maximum at point "a" and Li(qi) at point "b". Note that the price of components q2 associated with "a" is lower than that associated with "b". Also notJ that a>b i.e. the MNE achieves a larger profit under countertrade in spite of the lower price of components. The reason behind this situation is that, given n, a lower price of components implies a lower marginal cost. A lower marginal cost of production means a larger final output. 19 2 The latter in its turn leads to both a larger demand for components and a large CT (% of final output that goes to the MNE). A larger demand for components means that (q2 - K) m(q2> is greater than or equal to (q^ - K) m(qi) because while q2 < qi, m(q2) > m(q;jJ . A larger CT means a large profit from selling CT in the international market. When the latter profit is added to the one from intermediary components, total profits under LC turn out to be larger than those under L. As n increases, the two curves L2 (q2> and Li(qx) shift downward to L2 ' and L]/ as we can see in diagram "c". We note that the levels of profits are lower in that case for both regimes LC and L (d and c respectively). However, the relationship between LC and L remains the same i.e. profits under LC are larger than those under L. The main reason behind the decrease in profits for both regimes is that as n increases final output decreases. If we follow the same procedure described above to compare profits gained by the MNE under the LC option (L2) to their counterpart under S (L3), we find that L2/L3 <1 for all values of j j (figure 9-1) . In other words, DFI larger profits for the MNE than countertrade does and is therefore a more attractive option. The main reason behind this result is that Qs , the final output under the S 193 option, is larger than its counterpart under LC, Qic. The large Qs implies a large producer's profit (L3) that is larger than (L2) in spite of the low price of components and the profit made on the sale of CT in the international market under LC. When we finally compare the performance of S to that of L, we also note the superiority of DFI as it generates more profits for the MNE than regular licensing does (L1/L3 <1 for all values of n) . This result is easy to explain because it follows directly from the other two above. If countertrade is superior to regular licensing and is at the same time inferior to DFI then it must be the case that regular licensing is inferior to DFI as far as the profits of the MNE are concerned. We finally note that as q increases L^, L2 and L3 tend to decrease at the same rate which leaves L2/L1, L2/L3 and L1/L3 constant as shown in figure 9-1. 9.1.2 Case Two: Monopolistic Market Structure and the Fixed Coefficient Production Function (model in section 7.2) What distinguishes case two from case one above is that Pi and P2 are defined differently. P^ and P2 are 194 assumed to be equal to yp and P respectively. While our main interest is in y >l, the case of industrial compensation, we will also investigate the cases of o<y<i. When o<y<ci, countertrade is the least desirable option for the MNE. As shown in (figure 9-2) both L2/L1 and L2/L3 are less than 1. If classified in order of preference for the MNE, DFI would rate first followed by licensing and lastly countertrade. This situation arises because when 0 <y < 1, Pi<P2 i-e. the MNE makes losses on the countertraded goods. To compensate for that loss, the MNE raises the price of components it charges the LDC. A high price of components leads to low demand and ultimately low profits for the MNE. In the case of y>i, however, we note from (figure 9-2) that L2/Li>1 which indicates that the MNE achives more profits under countertrade than under a regular licensing agreement. The reason behind this result is that when y >1 not only does the MNE make profits on the countertraded goods but it also makes higher profits on the components because it charges a lower price which increases demand as explained in section 7.2 above. Finally, when we compare LC to S with y>i, we note that DFI remains superior to countertrade even though the MNE now makes positive profits on the countertraded goods. 195 The reasoning behind this result follows closely the one provided in case one above when comparing the same two alternatives. 9.1.3 Case Three: Duopolistic Market Structure and the Fixed Coefficient Production function (model in section 8.3^ The main difference between case three and case one above, is the change in the domestic market structure. This difference, however, does not seem to change any of the results reached in case one above as far as the comparisons between (LC and L) and (L and S) are concerned. As shown in (figure 9-3) the profits of the MNE under countertrade are larger than those associated with a regular licensing agreement (L2/Li>1 for all values of n) . The latter alternative is also inferior to DFI (L2/L3<1 for all values of n) . The reasoning behind those results is exactly the same as the one given in the previous case. An interesting question to ask, however, is how different the MNE's profits under LC are between the monopoly and duopoly market structures? Using computer simulation to answer this question, by comparing L2 under duopoly to L2 under monopoly, we reach the conclusion that profits under duopoly for the MNE are higher than those 196 under monopoly. The main reason behind this result is the nature of the duopoly market structure which results into a larger final output given any particular level of the elasticity of demand. A larger final output, in its turn, means both a larger demand for components and a larger CT. We finally note that since q2 or the price of intermediary components turned out to be higher in duopoly than it did in monopoly, as we've seen in section five, the profits on components for the licensor are larger in duopoly than under monopoly because the difference between q2 and k is larger. A larger q2 also has a positive effect on the second part of profits under LC as it means a larger difference between and P2 which in its turn means a larger profit per unit of CT. The superior performance of countertrade under duopoly has also made countertrade a more attractive option for the MNE when compared to DFI (L2/L3>1 for all values of n) as shown in (figure 9-3). This is exactly the opposite of the result reached in case one above. The above described changes due to the duopoly market structure have boosted L2 to a higher level than L3. This in spite of the fact that Qs is still larger than Qic under the new domestic market structure. We finally note that the relationship between the various ratios of profits and follows the same pattern 197 described in case one above. 9.1.4 Case Four; Monopolistic Market. Structure and Cobb-Doualas Production Function (model in section 8.4) If we compare LC to L and S following the same procedure as in cases one and two, we reach the following conclusion: Given a and n,S or DFI generates more profits for the MNE than countertrade and licensing do. If we consider the latter two alternatives alone, however, countertrade is the more attractive option for the MNE. This is exactly the same result reached in case one with the fixed coefficient production function which indicates that the change in the production function to a Cobb Douglas produciton function does not alter the rating of the three alternatives as far as the profits of the MNE are concerned. Figures 9-4 and 9-5 show the change in L2/L1, L2/L3 and L1/L3 as n and a change in respective order. The change in either one of the two parameters results in a lower output for all three alternatives L, LC and S which leads to a decrease in all three expressions for profit in equations (9-1 through 9-3). Since the difference between L^,L2 and L3 also decreases in the process, the ratio L2/L1, L2/L3 and L1/L3 also decrease. We finally note 198 that, just as in cases one, two and three above, as n increases Lj_, 1>2 and L3 tend to decrease at the same rate which leads to constant ratios. Concluding Remarks We have shown in this section that, given the specifications of the model and the definition of countertrade, the claim that Western companies make losses when using countertrade needs to be qualified in more than one way. First, when compared to a regular licensing agreement, countertrade was superior in three of the four cases we analyzed. The only exception was when we allowed for Pi < P2 i.e. we relaxed the assumption that the MNE always makes profits on the countertraded goods. This implies that when it is difficult to dispose of the countertraded goods at a profit, as it is often the case under commercial compensation, countertrade is not a desirable choice for the MNE. In the case of industrial compensation, however, where this is not a problem the evidence for the superiority of countertrade is substan tial . Second, when compared to DFI, countertrade was found to be inferior to the other alternative. In other words, the MNE makes higher profits under DFI than it does under countertrade. This situation was completely reversed, 199 however, when the domestic market structure was changed from monopoly to duopoly. In that case countertrade was the more attractive option. We can then conclude that several factors are at work as far as the comparison of DFI and countertrade go and therefore the above claim cannot be accepted or denied in any definite way. 9.2 Equilibrium and the Relevance of Transactions Cost Theory. In all previous sections we have been looking at the LDC and the MNE as two seperate entities, each trying to choose among S,LC and L the regime that maximizes its welfare. The truth, however, is that the MNE and the LDC are not seperate. They coexist and their choices of the various options available cannot be independent. The purpose of this section is to combine the MNE and the LDC together in the same picture to analyze how their joint decision making takes place. In other words, the focus here is on general equilibrium rather than partial equilibrium. 9.2.1 When an Equilibrium Is Reached Assuming that both the LDC and the MNE are aware of the forms of agreement that maximize their welfare, an 2 0 0 equilibrium is reached when they agree on a specific option. From the analysis in section 9.1 and in chapters 7 and 8 , we note that either one of the following two situations seems to arise: 1) The same regime maximizes the welfare of both the LDC and the MNE and in that case the equilibrium is unique. In our model the unique equilibrium is typically S or DFI. 2) One regime maximizes the welfare of the LDC while a different one maximizes that of the MNE. This seemed to be the situation in several of the cases analyzed. Typically the choice is among S and LC, but often involves L as well. In the latter case the equilibrium is not unique and choosing between equilibria is a problem. We can represent both situations by diagram "d", below, which presents the payoffs of each of the two sides under S, LC and L. The row payoffs (a,0,0), (0,c,0) and (0,0,e) represent the payoffs of the LDC under S, LC and L respectively. The column payoffs represent those of the MNE. The payoffs in all boxes other than the diagonal ones are 0 because the two parties have to agree on the same option if the project is to be executed and if an equilibrium is to exist. If, for example, a>c>e and b>d>f then (a,b) that stands for DFI exhibits salience over (c,d), countertrade, and (e,f), licensing, and it is the unique equilibrium. Suppose, 2 0 1 however, that (a,b) and (c,d) are both superior to (e,f) but at the same time a<c and b>d. In that case both (a,b) and (c,d) are equilibrium situations. Only one of the two can prevail, however, and it is in the choice among equilibria that transactions cost play a role. 9.2.2 Transactions Costs and the Choice Between Equilibria The choice between equilibria can be analyzed from two different perspectives: bargaining perspective and transac tions cost perspective. The bargaining framework is the most familiar framework for analyzing the relationship between the MNE and the hosting LDC (Teece, 1986). On one side, the MNE is depicted as having the technology, experience, the skills and access to finance and markets that the LDC needs. On the other side, the LDC is depicted as having the resources, labor force and other factors which can often be configured to provide an attractive investment for the MNE. The assets that each party has, determine its bargaining power on the negotiating table, the party that is more powerful will use its power to coerce the other party into accepting a form of agreement that is not the most efficient from the latter's point of view. For instance, if the MNE is more powerful than the LDC, DFI will probably be chosen even though it does not 2 0 2 maximize the welfare of the LDC. The situation is reversed if the LDC is the more powerful party. Negotiating power also depends on the special nature of the project and how badly it is needed by both parties. For instance, if the LDC badly needs the specific technology provided by the project then it may give in to a less efficient agreement with the MNE, from its point of view, just to get this technology. A similar attitude will prevail if this technology can only be provided by this specific MNE or only few others that are harder for the LDC to reach. On the other hand, if this specific LDC is paticularly well equipped for the execution of this specific project, the MNE may give in to its demands. Also if the MNE desperately needs this specific market, it may still accept a form of agreement that it wouldn't accept otherwise. If we look at the choice problem in a transactions cost analytical framework, we note that in choosing between S, LC and L the LDC and MNE are basically choosing between three forms of contracts. The application of transactions cost theory to contract choice is based on the idea that each category of contracts has advantages and disadvan tages. The form of contract that minimizes the transac tions cost is the superior one. It is interesting to note 203 that while we already know from the model which of the two forms of investment is superior for each party, it is the transactions cost which determine the actual profits and these in their turn influence the choice between the two equilibria. While DFI, or S in our model, has been known for being a vehicle for the transfer of technology to the LDCs, empirical evidence has proven that there is plenty of room for opportunistic behavior on the part of both the MNE and the LDC under this form of investment. Several studies (for ex. Dunning, 1979; Hawkins and Prasad, 1981) have attempted to measure the extent of the technology transfer and benfit to the LDCs through DFI. Most of them came to the conclusion that by and large the subsidiaries do not fulfill their promises and tend to exploit local markets rather than benefit them. LDCs often complain that MNEs do not meet their promises of export targets because they often find the local market more profitable. At the same time, MNEs complain of opportunistic behavior on the part of the LDCs. Once the deals are signed and assets, typically hard to withdraw, are deployed by the MNE on the host country soil, the LDC is able to bring pressures to bear for "renegotiations", "adjustments", "surtaxes", "recomputations" and the like- all manifestations of expost contracting. From the point of view of the MNE, the LDC begins to cheat on them (Moran, 1974; Mikesell, 1971; Teece, 1986). If we consider the case of LC or countertrade, we find that linking the import of technology by the LDC to the export of products produced by that technology to the MNE would tend to overcome the opportunistic behavior on the of the MNE that is described above. The relationship between the two parties does not end at the sale of technology but extends far beyond which in a way guarantees that any exploitation on the part of the MNE will be reflected in the quality and pricing of the products it gets back. This situation tends to alter the incentives of the MNE more towards fulfilling its promises to the LDC. At the same time, however, because so much is still unknown about countertrade and there are no specific universal rules governing it, most studies agree that negotiations are often costly and complicated (for ex. Business Internation al Research Report, 1984). After describing some of the factors that determine the transactions cost on both forms of investment LC and S, the question is which one of the two is superior? The answer really depends on the situation. For instance, An LDC that has a favorable previous experience with DFI and 2 05 dreads the involvement into an unconventional method of trade as countertrade would tend to favor S even though it doesn't maximize its welfare. Also, an LDC that is not aware that countertrade maximizes its welfare because of all the conflicting arguments in the business media, the uncertainty of the trade environment and the lack of information on countertrade would also tend to favor DFI. Similarly, a MNE that is well equipped to handle countertrade agreements and that has long term goals with this particular LDC would favor countertrade to DFI. ALso a MNE with previous successful experience with countertrade or unsuccessful1 experience with DFI would prefer LC to S. We finally note that while we've concentrated above on the choice between only two of the regimes, namely the ones that maximize the welfare of the LDC and the MNE, there is one last possiblility that deserves attention and that is the fact that negotiating costs may be so high and so complicated that both sides may choose to avoid them by settling on the third regime which is an inferior option for both of them. One important point that we ignored in the above analysis is the specific nature of the industry that we are considering. All factors that we discussed will probably change considerably in their effect from one industry to another. It is very unfortunate that we don't have 206 empirical evidence from the car industry to support or refute the conclusions of this model mostly because data on countertrade transactions in general are very scarce let alone transactions in a specific field. 9-3 Conclusions of the Model and Reflections on the Case Studies In chapters 4 through 6, we have raised a few questions concerning the welfare implications of counter trade as based on the available information on the Egyptian and Romanian experience with countertrade, as well as on the attitudes of Western firms towards countertrade. The purpose of this section is to combine the most important results reached by the countertrade model, and explore to what extent they answer our questions, and what new information or concerns they add to what we already know about countertrade. One thing the model explains is why LDCs and EECs find countertrade, in the form of industrial compensation, attractive. The financing provided by countertrade and the guaranteed exports are two well known reasons. What the model brings out, however, is the change in the incentives of the MNE that occurs as a result of countertrade. In the comparison between countertrade and licensing, it was shown 207 how the linking of the two transactions, the import of the technology and the export of the final output as a payment for this technology, via countertrade reduces the exploitative power of the MNE for the LDC leading to lower prices for the imported components. Countertrade, in the form of licensing with payment in resultant products, also turned to be superior to DFI which indicates that a licensing agreement would be superior for the LDC welfare if the exploitative motives of the MNE are curtailed via linking the two transactions. The change in the incentives of the MNE could lead to better technology transfer as well a generally more useful relationship between the LDC and the MNE. The technology transfer in our model is incorporated in the components that the LDC imports from the MNE. The model, however, confirms our reservation on countertrade as far as the pricing system used in these agreements is concerned. The fact that the LDC or EEC pays for its imports in goods does not mean that the prices specified in each transaction don't matter. Our analysis pays special attention to the price of the countertraded goods that the LDC pays the MNE in return for the components it provides. As explained in chapter 8 , if the prices are not correctly specified countertrade could be inferior to the other two alternatives as far as the 208 consumer and producer's surpluses are concerned. The results are also conditional on the type of production function, the elasticity of demand and the market structure, which indicates that there is no genralized conclusion in this matter. The important point, however, is that the LDCs could be making losses on the countertraded goods. More generally, it implies that LDCs could be losing sale opportunites in the traditional multilateral trade network. This hypothesis cannot be adequately assessed, however, unless the costs associated with LDC exports using multilateral trading practices, due to trade barriers on the part of DCs and LDCs serious debt problems, are also taken into consideration. Although consumer and producer's surpluses are by far not the only measures of welfare for a country, the results of the model suggest the importance of studying how countertrade affects the domestic market and the domestic consumers and producers. While exports are important, what happens if too much is exported and the consumers remain without a needed product? The case will certainly differ from one commodity to another but the fact remains that the effects of countertrade agreements on the domestic market need serious consideration on the part of LDCs. Another interesting result is the persistent inferior ity of countertrade, in the form of commercial compensa- 209 tion, to the other two alternatives as far as the welfares of the LDC and MNE are concerned. The main reason behind the poor performance of commercial compensation in our model is the difficulty faced by the MNE in disposing of the countertraded goods which causes losses for the MNE which are in their turn reflected into higher prices for the components purchased by the LDC. While commercial compensation has not been the main focus of the model, and can certainly be more adequately represented in another framework, this result reveals another aspect of the relationship between the Western company and the LDC or EEC. If the Western company incurs losses, in disposing of the countertraded goods, it could very well raise the “prices to be paid by the LDC or EEC to accomodate those anticipated losses. This partly explains the complicated negotiations typically associated with countertrade especially when the EECs are concerned, as explained in detail in chapter 5 above. It also explains why the Western partners always prefer raw materials and sometimes services as opposed to finished products when conducting commercial compensation transactions with EECs. This specific problem should not arise, however, in the case of industrial compensation because of the special nature of the products involved, as we explained above. In spite of the fact that the definition of the 2 1 0 welfare of the MNE as profits in the countertrade model does not incorporate all the long term targets that firms have when using countertradehowever, it was found that countertrade is superior to regular licensing in all cases which means that positive profits for the Western partner can be achieved with countertrade. This result in a way explains the willingness of the MNEs to get involved in those complicated countertrade transactions. Finally, the model captures the complicated negotiating procedure that takes place between MNEs on one side and LDCs and EECs on the other side. Under different conditions a particular form of investment is better for each party which leads to a conflict of interest that can be settled only depending on the nature of the project and the experience of all parties involved with countertrade and other forms of investment. Finally, it is important to recognize some of the limitations of the countertrade model developed in this study due to using simplifying assumtions. First, the measure of the LDC's welfare as consumer surplus plus producer/s profit is often criticized for not being the best measure of welfare (Leibenstein, 1966). It was used here, however, following the original basic model by Bardhan as a simplifying assumption. While it captures one important aspect of the LDC's welfare, as we explained 2 1 1 above, it ignores other effects that are often even more important for the LDC, such as the importance of promoting exports, adequate technology transfer and the importance of financing. A general evaluation of countertrade will have to take account of all those factors besides the ones “ considered in the model. Second, partial equilibrium was the basic method of analysis. General equilibrium was considered only briefly in the last section. Third, in comparing the alternative regimes Cournot-Nash assumptions were assumed whenever a duopoly is involved. The crudity of those assumptions is well known. It was used in this study, however, because it is simple and easy to handle in the calculations. Finally, income distribution effects were not taken into account in this model. Finally, we note that aside from shedding light on how countertrade affects LDCs and MNEs relative to licensing and DFI, the aim behind this portion of the study is also to illustrate the importance of theoretically modelling countertrade because it is the only way to get reliable conclusions that could help LDCs and MNEs alike in their decision making. While it is very unfortunate that the results reached cannot be tested empirically due to lack of data, the work done here is still important as a first step in this direction. 2 1 2 Figure 9-1. Case One; The Relationship Between the Elasticity of Demand and the Ratio of Profits. 2 .5 2 ,4 2,2 0 .4 ELASTICITY OF DEMAND + L 2/L 3 Diagram "c" w H * » ■ L2/L1 &L2/L3 Figure 9-2. The Relationship Betweeny and the Ratio o£ Profits Kl H Vi / V Vi V .* 0, 9 - 5 D L2/L1 + L2/L1 Figure 9-3. Case Three: The Relationship Between the Elasticity of Demand and the Ratio of Profits. < n t z t i . o <r o . b . 0 < < K 1,7 0.7 0.6 " 0.5 14 12 10 4 6 N> H < T n L2/L1 elasticity or demand + L 2 /L 3 o LI / L 5 Figure 9-4. Case Four; The Relationship Between the Elasticity 2.5 - 2.6 - 2.4 ~ 2.2 ~ 0,6 ~ 0 . 4 - 0,2 ELAsncmr o f demand + L2/L3 L1/L5 RATIO OF PROFITS Figure 9-5. Case Four: The Relationship Between Labor Elasticity of output and the Ratio of Profits. 3 .5 H 2 .5 H 0 ,5 H 0,1 0 .7 LABOR ELASTICITY OF FINAL OUTPUT D L2/L1 4 1 2 /L 3 L 1 /L 3 N> H 09 MNE S LC L a 0 0 s b 0 0 0 c 0 LC 0 d 0 0 0 e L 0 0 f Diagram "d" 219 CHAPTER 10 CONCLUSIONS AND SUGGESTIONS FOR FURTHER RESEARCH 10.1 Conclusions of the Study This investigation of countertrade reveals, first of all, that there seems to be a clear contradiction between the official and unofficial attitudes of Western governments and various official organizations towards countertrade. Western governments are caught in the dilemma of needing countertrade and at the same time refusing to accept it officially because it is assumed to be a primitive and inef ficient mode of trade. The same applies to the OECD, GATT and IMF; they condemn countertrade but at the same time seem unable to force their members not to use it. The problem is really more of a political problem than an economic one. Each one of these countries and organiza tions is trying to set a high standard by refusing to honor anything other than free trade; at the same time, however, it doesn't want to jeopardize its interests by not using countertrade. As a result, each country portrays a public image that belies private practice. The attitude of the Western governments and the international organizations has led to a situation of chaos as far as countertrade is con cerned. There is no official recognition of countertrade transactions, and no standardized rules or regulations gov 220 erning the commitment of the parties involved. While we do not claim that countertrade is faultless, or that it is more efficient than free trade, we do suggest that countertrade be regarded as simply a new twist on an ancient but practi cal way of doing business that comes in handy given the shaky worldwide financial situation, extensive protectionism and sectoral trade restrictions that impede free trade. The Egyptian experience with countertrade reveals what countertrade is capable of achieving for LDCs in terms of technology transfer, preservation of hard currency and new opprtunities for exports all without putting additional bur dens on the government budget. It also reveals, however, the possible risks associated with the use of this form of trade such as the possible loss of traditional export mar kets as well as the lost opportunities in the multilateral trade network, if the products are sold at prices lower than those prevailing in the international market. These addi tional costs associated with countertrade are of signifi cance only when compared to those incurred by Egypt and other LDCs when following the traditional multilateral trade practices, given their serious external debt problems. Gen erally speaking, however, countertrade cannot be perceived as the solution to LDCs economic problems; in fact, as ex plained in the case of Egypt, permanent solutions to the latter problems are likely to increase the benefits acquired 221 by Egypt from the use of countertrade. While the limited Egyptian experience with countertrade left us with questions more than answers as far as the actual practice of countertrade is concerned, the Romanian case study revealed a lot of the details of the practical side of the countertrade agreements. Commercial compensa tion agreements proved to be highly problematic as far as the Western companies are concerned mostly due to the infe rior quality of the products provided by EECs in general, and Romania, in particular, which makes disposal of these products difficult and costly. As far as industrial compen sation is concerned, however, the specific project described in the case of Romania reveals a mutually beneficial rela tionship between Romania and its British partner, pointing to the potential of countertrade for the industrial develop ment of LDCs. As far as the Western firms involved in the counter trade agreements are concerned, they seem to be divided into two groups: "defensive" and "offensive", depending on their attitudes towards countertrade. Firms in the defensive cat egory try to avoid countertrade as much as possible while those in the offensive one tend to use it as an additional tool for achieving their long-term objectives. The counter trade transactions presented in chapters 4, 5 and 6 reflect the latter attitude and how it led to long-term benefits 222 that go beyond the short-run profits. The important point to note is that the sooner the Western firms start accepting countertrade as a way of doing business that brings about flexibility in an otherwise inflexible situation, due to the worldwide economic problems, the sooner they will benefit from its use. The more experienced the Western firms are with countertrade, the more they learn to use it profitably. European firms are believed to be more experienced than American ones in that respect. The various examples of countertrade transactions pre sented throughout this study also tells us something about the nature of countertrade transactions, each transaction is unique and is shaped depending on the needs of the parties involved. In fact, even an attempt to categorize them as described in chapter 2 is difficult because typically each transaction contains some features of all forms of counter trade. The flexibility of countertrade opens a whole range of possibilities that could be extremely beneficial to all parties involved if properly exploited. Generally speaking, however, our investigation reveals that countertrade in the form of industrial compensation is more efficient than com mercial compensation. The theoretical portion of the study takes on where the case studies left off. Paying specific attention to indus trial compensation, it attempts to evaluate the welfare im 223 plications of countertrade, for LDCs and MNEs, in comparison to DFI and licensing; the latter two being other forms of investment not involving any linkages between import and export transactions. Given the assumptions of the model, we conclude that countertrade in the form of industrial compen sation is superior to licensing and DFI as far as the wel fare of the LDC is concerned mainly because it alters the incentives of the MNE to the benefit of the LDC. This re sult, however, is highly conditional on the prices of the goods involved especially those of the countertraded goods or the goods the LDC pays the MNE in return for its technol ogy. The further away this price is from the domestic price, the larger the cost involved. The results of the model also indicate that the effects of countertrade on the domestic market need serious consideration on the part of LDCs. Those issues are often ignored by LDCs as more atten tion is paid to the other obvious advantages of countertrade such as increased exports and the easy financing of the projects. The model also evaluates the merits of countertrade as far as the MNE is concerned. In spite of the fact that it does not incorporate all the long term benefits that could be achieved by MNEs, as explained in chapter 6, we conclude that countertrade is superior to licensing as far as the profits of the MNE are concerned which in a way explains why 224 even the defensive firms get involved in countertrade trans actions. The MNE profits turned out to be inferior to DFI, however, in most cases analyzed. Finally, the model presents the outline as well as the reasons for the negoti ating complications typically faced when there is a conflict of interest between the two parties involved. The case of commercial compensation was also briefly considered by the countertrade model. Countertrade turned out to be inferior to the other two alternatives as far as the welfares of LDCs and MNEs are concerned which points to the conclusion that the benefits of the LDC from counter trade are in a way linked to the success of the MNE in disposing of the countertraded goods. This reaffirms the importance of the specification of the prices of the various products exchanged under commercial compensation, as the Western partner is likely to raise the prices of the com modities sold to LDCs or EECs to account for the cost of marketing the countertraded goods. Finally, a general comment that follows from this in vestigation of countertrade is that: while the efficiency of multilateral free trade in the GATT framework is generally indisputable, it is precisely the barriers that impede this form of trade added to the shaky.financial situation world wide and the debt problems of the LDCs that led to the emergence of countertrade in the first place. A recovery of 225 the world economy is likely to put an end to the use of countertrade. However, until this happens countertrade is a fact of life that should be organized rather than condemned on political grounds. Our study shows that countertrade, especially in the form of industrial compensation can be beneficial to all parties involved and could be even more so if it were appropriately regulated and understood. 10.2 Suggestions for Further Research Throughout the analysis in this study, several ques tions have been raised as far as the effects of the counter trade agreements on the LDCs and EECs involved are con cerned. Unfortunately, several of the questions relating to the trade creation and trade diversion effects of counter trade, as well as its long term effects on the domestic markets of the countries involved, are left pending mostly due to the lack of detailed information on countertrade and the limited experiences of the different parties involved, especially LDCs. An important and interesting line of re search would be to follow the progress of the present coun tertrade projects over time and indicate the resulting changes in various aspects of the economies of the countries involved. An investigation of the trade creation and trade diver sion effects of countertrade is particularly interesting 226 because an adequate evaluation of countertrade would be in complete without it. This issue becomes even more intrigu ing if we refer to the detailed study by OECD (OECD, 1979b) on the development impact of barter in LDCs, where a number of countries (India, Egypt, Ghana, Nepal, SriLanka and Tunisia) were examined. The focus was on the trade creation and trade diversion aspects of bilateral trade. Among the many questions asked were: (i) has bilateral trade per se induced the country to move away from its line of compara tive advantage? (ii) have the terms of trade been less fa vorable under bilateral trade than under multilateral trade? The answer to both questions was negative for all six coun tries. In other words, the bilateral trade agreements that were heavily criticized in the Egyptian case study have proved to have been as advantageous as multilateral trade. The obvious question to follow would then be, how counter trade, which is certainly more flexible and more multilater al in nature than the older bilateral agreements, would score in comparison to multilateral trade especially when taking into consideration the debt problems and trade re strict tons that forced its existence in the first place. With respect to industrial compensation, an interesting field to explore is how similar or different is this partic ular form of countertrade to international subcontractting (ISC). Recently, there has been a surge of interest in ISC 227 as being useful for LDCs and contributing to the more far-reaching phenomenon of a new economic order. ISC has been described by OECD (Germidis, 1980;, Oman, 1984) as not very useful for the industrialization of the LDCs because of two reasons:(i) the short-term relationship between the principal and the subcontractor in an ISC deal which doesn't provide enough time for the LDC (the subcontractor) to ac quire know-how of production; and (ii) the dependency of the subcontractors on DC principals which frequently dictate production features and technical specifications with which the subcontractor has to comply to avoid losing the con tract. Moreover, the goods produced and the facilities set up need not necessarily be what the LDCs want for their long-run industrialization purposes. In industrial compensa tion transactions, most of the above shortcomings of ISC are not likely to exist as clear from the detailed analysis of industrial compensation in this study. This confirms our conclusion that industrial compensation could very well be beneficial to the industrialization of LDCs. At the same time, it motivates our interst to further explore the dif ferences and similarities of ISC and industrial compensa tion, both being issues not receiving enough attention in the literature, despite their importance. One last issue to explore would be the possibility of global countertrade, or more precisely the effects of coun 228 tertrade on world trade, as well as its effects on the various parties involved, as more counttries and more firms use it. Our study has been confined to the advantages of countertrade to the individual Western firm and to the indi vidual country, the question is whether those advantages will continue to exist as more parties get involved. For instance, in the case of Western firms, the evidence seems to indicate that a Western firm that accepts countertrade demands on the part of LDCs or EECs goes one step ahead of its competitors and benefits as a result. Consequently, its gain is in a way based on providing something the others don't, the important question to follow is, what will happen if all firms do the same thing? Will these benefits contin ue to exist or are they exclusive to new entrants as is the case with Schumpeterian innovations? Also important is whether the same situation could arise as more and more LDCs use countertrade. Finally, whether global countertrade is or isn't a likely possibility, is another important issue to explore. Generally speaking, however, more interesting is sues of research are likely to come up as long as the use of countertrade continues to expand and if more attention by economists is given to it. 229 REFERENCES Assaad, A. "It's time to make barter legitimate," Eu- romoney, (January 1984), pp. 136. j Banks, G. "The Economics and Politics of Countertrade," The World Economy, (June 1983), pp. 167-197. Bardhan, P. "Imports, Domestic Production and Transna tional Vertical integration: A Theoretical note," Journal of Political Economy, 90, no 5 (1982), pp. 1020-1034. Barovick, D. "US Banks Plunge into Export Trading," Euromoney, (January 1984), pp. 128-130. Bertsch, G. and J. McIntyre. National Security and Technology Transfer: The Strategic Dimensions of East-West Trade. Colorado: Westview Press, 1983. Business America, Special Issue. "Marketing Opportuni ties in Communist Countries," US Department of Commerce, 5 October 1981. Business International Institute. "The Future of coun tertrade". Seminar on New Developments on Doing Business with Eastern Europe, Vienna, October 1981. Business International Research Report. New Ways to Sell, Finance and Countertrade, ness International Corporation, 1983. Eastern Europe New York: Busi- tertrade Opportunities in Africa, national Corporation, 1984a. ------- . Exploring Coun- New York: Business Inter- •yk -------------------------------------- . Threats and Op- / / f / portunities of Global Countertrade. New York: Business In ternational Corporation, 1984b. Chesser, T. "Barter Becomes Big Business in World Trade: Syrup for Vodka, Computers for Art, Jets for Ham is Often the Only Way to Cut a Deal,"The New York Times, 26 July 1981, p. 15. 230 REFERENCES (continued) Collins, S. "Green Lights for OS Banks to Barter?" Eu- romoney, (May 1983) pp. 160-162. Countertrade Outlook, 7 January 1986, p. 1. Dunning, J. "Technology Exporters and Technology Trans fer controls." TTCS Conference, Seattle (mimeo.). Eason, H. "Barter Boom," Nation's Business, (March 1985) pp. 18-24. ^ Elderkin, K. and W. Norquist. Creative Countertrade. Cambridge: Ballinger Publishing Company, 1987. Everett, M. "OS Firms are Pressed to Offer Barter Terms by Overseas Customers," The Wall Street Journal, 18 May 1977, P. 1. -----------. "Countertrading Grows as Cash Short Na tions Seek Marketing Help," The Wall Street Journal, 13 March 1985, p. 1. V Galbraith, C. and N. Kay. "Towards a Theory of Multina tional Enterprise," Journal of Economic Behavior and Organi zation, 7 (1986) pp. 3-19. Germidis, D.(ed.), International Subcontracting: a New Form of Investment. Paris: OECD, 1980. Hawkins, R. and Prasad, A. (eds.). Research in Interna tional Business and Finance: Technology Transfer and Econom ic Development, London: JAI Press Inc., 1981. / Hill, M. East-West Trade, Industrial Cooperation and Technology Transfer. England: Gower Publishing Company, 1984. Hodara, I. "Countertrade- Experiences of Some Latin American Countries," Geneva: UNCTAD, 1984. Korth, C. (ed.). International Countertrade. New York: Quorum Books, 1987. 231 REFERENCES (continued) Leibenstein, H. "Allocative Efficiency Vs X-Efficien- cy", American Economic Review, 56 (June 1966) pp. 392-415. Interview by Author- Dr. Atef El Biblawi, the President of the Egyptian Bank for Export Development (EBED), (Summer 1986). Interview by Author- Dr. Demos Verdiabasis, Professor at the School of Business and Management at Pepperdine Univer sity and a Consultant in the Area of International Trade and Business Strategy, (Spring 1987). Interview by Author- Eng. Ezeldine Hilal, The President of El Nasr Automotive Manufacturing Company, (Summer 1987). Interview by Author- Mr. Fouad Sultan, the Egyptian Min ister of Tourism, (Summer 1987). Interview by Author- Mr. Kamal Hilaly, the President of El Nasr Export Import Compa ny, (Summer 1987) Interview by Author- Eng. Mohamed Abdel Wahab, the Egyp tian Minister of Industry, (Summer 1986, 1987). Interview by Author- Mr. Nasr Sheta, the President of the Arab Company for Radios and Televisions, (Summer 1987). deMarinis, R. et al.. Analysis of Recent Trends in US Countertrade, USITC Publication 1237, March 1982. Mikesell, R. (ed.). Foreign Investment in the Petroleum and Mineral Industries: Case Studies in Investor Host Coun try Relations. Baltimore: JohnsHopkins University, 1971. Moran, T. Multinational Corporations and the Politics of Dependence: Copper in Chile. Princeton, N.J.: Princeton University Press, 1974. Oman, C. New Forms of International Investment in De- .eloping Countries. Paris: OECD, 1984. y Organization for Economic Cooperation and Development '(OECD). Countertrade Practices in East-West Economic Rela- tions. 1979a. 232 REFERENCES (continued) -------• The Development Impact of Barter in Developing Countries; Synthesis Report. 1979b. ------ . East-West Trade - Recent Developments in Coun- tertrade. 1981. -------. Countertrade; New Developing Country Prac- tices. 1985. Paliwoda, S. Joint East-West Marketing and Production Ventures. England; Gower Publishing Company Limited, 1981. Pine, A. "Hindering Help; Debt Ridden Nations Impose Many Barriers on Foreign Investors," The Wall Street Jour nal, 3 December 1984, p. 1. Pisar, S. Coexistence and Commerce; Guidelines for Transactions Between East and West. New York: McGraw Hill Book Company, 1970. Schmalensee, R. "A Note on The Theory of Vertical Inte gration," Journal of Political Economy, 81, no.2 { March/April 1973) pp. 442-449. s ? Teece, D. "Transactions Cost Economics and the Multina tional Enterprise- an Assessment," Journal of Economic Be havior and Organization, 7 (1986) pp. 21-45. Y' OS Department of Commerce. East-West countertrade prac tices. Washington: OS Government printing office, 1978. X Vardiabasis, D. "Countertrade: New Ways of Doing Busi ness," Business to Business Magazine, (Spring 1985) pp. 35-36. --------------. "Countertrade, MNC's and the US Trade Deficit". Economics Department Seminar, DSC, February 1987. 233 REFERENCES (continued) Verzariu, P. Countertrade Practices in East Europe, the Soviet Dnion and China: an Introductory Guide to Business. Washington, D.C.: OS Department of Commerce, International Trade Administration, 1980. -----------* Countertrade, Barter and Offset. New York: McGraw-Hill, 1985. Walsh, J. "Countertrade, not Just for East/West Any more," Journal of World Trade, (1983) p. 3. Warren-Boulton, F. "Vertical Control With Variable Proportions," Journal of Political Economy, 82, no. 4 ( July/August 1974) pp. 783-802. Vogt, D. et al.. Barter of Agricultural Commodities: IED Staff Report, OS Department of Agriculture, April 1982. V Welt, L. Countertade Business Practices for Today1s World Market. New York: American Management Associations Publications Division, 1982. X ---------• Trade Without Money: Barter and Countertrade. New York: H.B. Jovanovich Publishers, 1984a. ^ -------. "Why Latin America is Wary of Barter,” Eu- romoney, (January 1984b) pp. 132-133. . Countertrade," Special Euromoney Report. 1985. ^ --------. "Countertrade as a Competitive Tool," Global ^Perspective, (January 1986) pp.53-56. Williamson, O. Markets and Hierarchies: Analysis and Antitrust Implications. New York: Free Press, 1975. Zarin, D. "Countertrade and the Law," Journal of Inter national Law and Economics, (1984). 234 APPENDIX A A Sample of Barter Contracts in Egypt Source: El Nasr Export Import Co., Egypt 235 COUNTERTRADE AGREEMENT BETWEEN GENERALEXPORT OOUR g e n e x-tekstil NARODNIH HEROJA 43 BEOGRAD,YUGOSLAVIA AND EL NASR EXPORT IMPORT CO.,A.ft. EGYPT The companies GENERALEXPORT in the Socialist federal Republic of Yugoslavia, on the one hand, and EL NASR EXPORT-1MPORT in the A.R.Egypt un the other hand,hereinafter called the two Contracting Parties ; Being desirous to find new means to increase their trade exchanges with the aim to contribute further to the development and expansion of the trade relations between their two friendly countries. Have agreed on the following : A.r t i c 1 e 1 . Counter deliveries of the products included in list "A" and list 'b‘ attached to the Agreement will be carried by the contract ini) parties in the two countries from the date on which the Agreement will enter into force. Both sines agreed to realise during 1987 equal transaction for the amount of 20 /Twenty/ million Dollars. List "A" includes the products of Yugoslav origin with their respective types and amount, sperified,which will be delivered to the Company EL NASR t.XPURT IMPORT in Cyypt. T h e Y u g u s1 a ; Exports will be of 10 /Ten/ Million Dollars. List “B" includes the products of Egyptian origin which will be delivered to GENERALEXPORT. The Egyptian Exports will be of 10 /ten/ Million Dollars . 236 The Lists ''A" and MBM are determined by both official approvals as stated in Article 7. and enclosed herewith. Article 2 . Any ammendrnent of the k i nds .quant i ty and value of the products exchanged and included in the two lists ”A“ and "B" attached to this Agreement can be made by written approval of the two Contracting Parties. Article 3. a) The exchange of the products included in the two lists "A" and "B" attached to this agreement will be effected in accordance with the laws and regulations which are in force in each country of the two Contracting Parties under individual Contracts to be duly concluded for this and among the Contracting Parties and the organizations in the two countries. b) The prices of the products exchanged under the provisions of this Agreement will be fixed in US Dollars according to the international prices prevailing on the world market, for such pruducts. The prices in the contracts are to be based on FOB value only. Article 4 . For execution of the Contracts under this Agreement , no commission will be paid from EL NASR to GENERALEXPORT or from uCNERAlEXPORI to EL NASR. Article 5. The payments relating to the fulfilment of the present Agreement should be made by irrevocable transferable documentary Credits witihin a special account which have to be opened by Barque Du Cairo in A.R.Egypt and Jugobanka-0snovna Banka,Beograd Yugoslavia. The Letters of Credit opened in frame of this Agreement must make reference to both the Countertrade Agreement and Banking Agreement. The above mentioned Banks will set up the Banking Arrangements necessary for the implementation of this Agreement. 23 In case Egyptian exports take place first they should be covereJ by . 1 letter of Guarantee in Free USA Dollars issued by Juyobanka in favour of EL NASR guaranteeing t+ie settlement of the outstanding balance in case of non-delivery of the counterpart of Yugoslav goods.Specimen of the required L/G is attached to the Banking Arranyement. Such Letter of Guarantee will be valid after issuance of counter Letter of Credits by EL NASR with or about the value of GENERALEXPORT1 s Letter of Credits. If contraciin'i parties do not "I the vessel to the Port of loaJinij stated by G E N E R AL E ; ■ ;’0k I or Lt- NASR on time , both l u n t r.u. tiny parties may negotiate instead of Bill of Lading, the Forwarding Certificate stating that goods have been prepared for shipment and stored in the port's warehouse. A_r t_i c_l_o _6 . It is tru- responsibility of the Contracting parties i.e. EL NaSR and GLNERALEXPOR 1 to ensure the implementation of the Co.init' trade Agreement and to settle any balances that would appear in the accounts witihin 90 days after the pre sentation of the shipping documents for each individual contract signed by both Contracting Parties. At tic I e 7 . 1 h i s A g m-iin- n t i s S u b j e i t to the I i it a 1 Approval of the Egyptian jml Yugoslav Authorities. In case this Ag reemr n t is not e * r< n1ed in whole by 31 . 1 2. 1987. hotn Parties will undertake necessary action with respective Au t hor 11 i e s to obtain t' h ■: e * i1 > t, t> i o n and/or aminendmen t s . Article 8 . The Agreement will automatically stand extended for a further period of one ye'ar beyond 31.12.198/ unless terminated by either side with a written notice three months before expiry. 238 Art icl e 9 . ARB ITRAT ION This Agreement snail be governed in accordance with the French law.All disputes arising in connection with the present Agreement shall be settled by means of mutual understanding.1n case not sloved it will be finally settled under rules of Conciliation and Arbitration of the Interna tional Chamber of Commerce in Paris. The arbitration will be held in Paris. Article 10. Tnis Agreement shall enter into force after final appro vals from both. Eqyptian and Yugoslav Authorities. Oone and signed in Cairo, on June 1st.1987 in two originals in the English 1 anguage , both are equal authentic. LIST "A" OF THE PRODUCTS OF YUGOSLAV ORIGIN AND THE VALUE OF THE GOODS: CUMPUNL N 1 I i i i - : MOTOR INDUSTRY US S 4.500.000,- STEEL BARS 1.0 0 0.0 0 0,- PAPERS AND CARTONS 2.500.000,- - Cigarette paper upto 1000 t.:S 1,5 Mil. - Aqua Fuge Paper upto 1000 t.:$ 1,3 Mil. - Plugwrape paper upto 1000 t.:S 1,3 Mil. - Duple* Board upto 1000 t.: S 0,5 Mil. TOBACCO 2.000.000,- Types : " P r i 1 ep","B a r1e y", " V r g i n i a" , " He r e t-gn v i n a " according to the Jemand. 2 3 9 --------------------i---------------- L , r t " B " OF THE PRODUCTS OF EGYPTIAN ORIGIN VALUE OF THE GOODS : COTTON ( 5.930 BALES) COTTON YARN FLAX PRODUCTS AND THE US S 5.500.000,- 3.500.000,- 1.000.000,- 240 APPENDIX B Proposal for the NEC Project in Egypt Source: Egyptian Government- Ministry of Tourism 241 PROPOSAL FOR EGYPT TOURISM PROJECT IN JAPAN PREPARED FOR: THE ARAB COMPANY FOR TRANSISTOR RADIO AND ELECTRONIC EQUIPMENT PREPARED BY: NEC CORPORATION IN COOPERATION WITH DENTSU INCORPORATED basic Concept 1) This project is aiming at promoting friendship and mutual understanding between Egypt, which has a great history, and Japan. 2) The outline of history and culture of Egypt is being known to a certain number of Japanese people, though it is not necessarily enough in its quantity and quality—wise as well. And accordingly, it shall be one of major issues for future from now onwards hov^ ,to deepen mutual understanding among people of all classes in both countries. 3) To do encouragement of this movement, it will be considered as the most effective measure to activate the exchange of the people of the both countries. Meantime, activities for totally introducing •'Egypt*' must be projected. 4) From the point of view mentioned above, NEC in cooperation with Dentsu will develop publicity- projects introducing the people and the culture of Egypt, with cooperation of the Government of Egypt and the Embassy of Egypt in Japan. 242 B. Purpose of the Project We shall set the one-year period starting from summer of 1967 as the project term, and we shall; 1) lay down and implement plans in order to send out approximately 10,000 Japanese tourists during the targeted period. i I j 2) The foreign currency acqujred by our projects j will be reserved lor Arab Co. to purchase NEC's ! TV kits. 1 For these purposes, we shall support newspapers, | magazines, TV programs, and publication to j introduce "Egypt", and to carry out cultural works such as exhibitions and symposiums. I I I C. Outline of Tourists Mobilization Plan The plan will be divided into 5 categories. 1) Group tour consisting' of college/university students and teachers.(approx. 2,000) 2) Group tour consisting of 1) tourists in general (approx.3,000) and 2) diving fans (approx. 2,000) 3) Group tour consisting of middle aged and overseas | tour fans (approx. 2,000) 4) Group tour consisting of people attracted through NEC distribution channel (approx. 1,000) I • D. PR activities to introduce Egypt 1) Newspapers/major magazines Arrangement for introductory articles on many aspects of the country to appear on representa tive newspapers and major magazines. 243 2) TV Programs Arrangement of TV programs to introduce the country on major TV stations including NHK. 3) Egypr friendship association To organize Egypt/Japan friendship association consisting of members of culture and intelligence society from various fields, who will serve as the Intermediary to introduce the country. 4} Symposium/Lecture To organize events in cooperation with the Egypt Embassy and other organizations. 5) Culture Center To est abl i sh/i ncre-ase civic courses, which are very popular in Japan, on culture, art, and history of Egypt. Details on the above activities are shown on page 5. E. Grounding for long-range development The one year grounding work including projects shown above, should be grand in conception, which will lead long and friendly relation between Egypt and Japan. - Expansion of student exchange programs — Exchange of cultural work in Iona ranne F. Required cooperation from Eqy;>’ . side In order to effectively carry out the projects, we would like to ask you for your kind coopera tion . 1) To facilitate for us to conduct research, data collection and negotiations, placement of a person in charge of the matter concerned of the department in the Government of Egypt is request ed. 244 2} The Egyptian Government Tourist Office is requested to join the promotional activities and to develop PR Implementation. 245 APPENDIX C A Sample of Countertrade Contracts in Romania Source: (Verzariu, 1980) p.70 246 247 Draft of a Counterpurchase Contract with Romania F R A M E C O N TR A C T concluded on the ------------------------------- 197X between _____________ and ROMCHIM, Bucharest, Bd.f Dacia 13. Chapter I 1) ROMCHIM and Messrs,______________________have concluded the contract N r-------------------------------------- for the supply of _____________________ amounting to 2i Further to the above conclusion, Messrs.__________ oblige themselves to purchase Romanian commodities mutually agreed upon, directly or through third firms, under competitive conditions to be established from case to case. 3) The value of Romanian commodities agreed upon rep resents ____ % of the contract value, that is _______ ____________ out of which 4> Messrs. ..................................... oblige themselves to buy and pay the Romanian goods foreseen under Point 3f above before_____________________ Chapter I I — Guarantee In case of failure of Messrs......... __ _ _ _.............. to ful (ill their obligations in contractual time, or if they fulfill them only partially, the company shall pay to ROM CHIM a penalty o f C r on the non-fulfilled partial value of the obligation. As a guarantee of the penalty payment Messrs._______ : — _______ will remit in favour of ROMCHIM a bank letter I guarantee (according to the attached drafti issued by a orresponding bank of the Romanian Bank for Foreign Trade. The receipt of the aforementioned bank guarantee letter conditions the acknowledgement on the part of Messrs. ROM- CII1M of entering into force of the contract N r___________ ( 'h n p t e r I I I —A r t i b r a lion—A r t ..................... __... ol the contract Nr. . ________ Chapter I V —F in al provisions The contractual parties agree upon that only t hose export contracts concluded with the Romanian exporting enterprises can be taken into consideration, as counter parties, which stipulate precisely a clause that "the export contract consti tutes a counter-party to contract Nr. __________________ ” Only the values of the goods contracted, delivered and payed after the coming into force of the contract N r ._____ _______________will be deducted. The values deducted are only the FOB and/or franco bor der of the exporting count-y voi.,..r. Irrespective of their value, or object, no contracts will bo taken into consideration without the above mention. Messrs. _____________________ and ROM CHIM shall keep record of the export operations contracted according to inis Frame Contract. The parties shall quarterly compare their records. This Frame Contract is an integral part of the contract N r .-------------------------------- and enters into force at the same time as the contract N r .___________ ____ _____ ROMCHIM Bucharest to >u 00 Bi.uk Letter of Guarantee for a Counter Purchase Contract with Romania BANK LETTER OF GUARANTEE lor fulfillment of contract N r---------- of RO- MAN1AN BANK FOR FOREIGN TRADE Bucharest Messrs. ROMCHIM, Bucharest and Messrs. have concluded on t h e _____ ( 'o u trad Nr. ________________ the Frame __________________ through which Messrs. . _______ _..._______oblige themselves to buy Romanian commodities according to Chap. I, Art. 3 and 4 and to Chap. IV. par. 1 and 2 as follows: Chap. I - Art. 3 — Art. 4 Chap. IV (par. 1 and 2l In case of nonfulfillment of the obligations stipulated in th e F ra m e C o n tra c t Nr. Chap. II of the aforementioned ------------- aeeortiiiij- F ra m e Contract, M essrs by a bank letter of guarantee, that is: are obligated to pay a penalty guaranteed Chap. II According to these stipulated above, we oblige ourselves irrevocably to pay in favor of Messrs. ROM CHIM up to the amount o f_____________________ any sum requested by you invoking Chap. II reproduce above, at your first and simple demand without any other proof except your declaration that Messrs. have not compiieu h u h ob ligations foreseen in Chap. II of the Frame Contract Nr. ___________________ concluded with Messrs. ROMCHIM. By virtue of this letter of guarantee we will immediately effect the payments, deliberately renouncing at the benefit of the division and discussion, without having the right on our part of opposing the payments requested, or to invoke another objection or any other formality of any kind on the part of Messrs._______or on our part, not to invoke currency restrictions of which Messrs. _ — ___------------- could prevail, and without being necessary for you to have recourse against Messrs._________ or to Arbi tration or to any Tribunal. The validity of this letter of guarantee expires 30 days after the time lim it foreseen in Chap. I art. 4 of the Frame Contract N r . ______________________for purchasing the Ro manian commodities, but can be automatically extended, without any formality with the delays agreed by the partners of the above mentioned Frame Contract. After the obligation under this letter of guarantee has been performed, this letter of guarantee shall be returned to us.

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Asset Metadata

Creator Abdel-Latif, Abla (author)

Core Title Countertrade: A theoretical and empirical investigation

Degree Doctor of Philosophy

Degree Program Economics

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Economics, theory,OAI-PMH Harvest

Language English

Contributor Digitized by ProQuest (provenance)

Advisor Nugent, Jeffrey B. (committee chair), Elliott, John E. (committee member), Kuran, Timur (committee member), Novos, Ian E. (committee member), Odell, John S. (committee member)

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c20-277289

Unique identifier UC11260075

Identifier DP23345.pdf (filename),usctheses-c20-277289 (legacy record id)

Legacy Identifier DP23345.pdf

Dmrecord 277289

Document Type Dissertation

Rights Abdel-Latif, Abla

Type texts

Source University of Southern California (contributing entity), University of Southern California Dissertations and Theses (collection)

Access Conditions The author retains rights to his/her dissertation, thesis or other graduate work according to U.S. copyright law. Electronic access is being provided by the USC Libraries in agreement with the au...

Repository Name University of Southern California Digital Library

Repository Location USC Digital Library, University of Southern California, University Park Campus, Los Angeles, California 90089, USA