Global business refers to international exchange of goods and services between different countries. Though, global business is a company doing trade all over the world. Distance means the amount of space between two places, objects or people. The distant trade dates back as early as the Stone Age in Europe. Sea-borne trading is the example of a common place used for trading before the Greek civilization. The 16th century trade was linked by ocean-based communications. The modern trade was started at the beginning of the 17th century.
Bilateral foreign direct investment FDIs is an agreement that shows the terms and conditions required by a private investor from a country to invest in another country. The agreement guarantees fair and equitable treatment, protection against expropriation, full security and free movement of resources. The concept of distance has been of great interest to many business scholars who attempt explaining the variations. The current paper discusses various concepts of distance used in international business.
Institutional Theory Concept
Markets in developing countries and emerging economies have less developed institutions that constrain their strategic decisions. Institutional theory gives three frameworks to differentiate aspects of institution profile and institutional distance. These pillars are: the regulatory pillar that encompasses all the rules and regulations of doing business, laws and regulations of a country. The cognitive pillar shows the structures of society, its social knowledge and cognitive structures such as stereotypes. The normative pillar stands for beliefs, values and norms that define expected behavior in a society. As a matter of fact, these pillars are based on different types of motivation being normative, coercive and mimetic and have differences in degrees of tackiness and formalization.
Effect of Institutional Framework to Bilateral Foreign Direct Investment
The three above pillars influence strategies and operations of investors in foreign countries. In addition, they moderate the acceptance of the multinational enterprises into the existing social rules, norms and cognitive structures in the host countries and facilitate the transfer of strategic organizational practices from the mother country to the host country.
Internalization concept is based in China, which is today’s largest recipient of foreign direct investment internally and the fifth largest outward foreign investor. Internationalization is the ability to cross boundaries in the process of economic growth. China qualifies for internationalization among the developing countries in the following levels, namely: exporting level, original equipment manufacturer (EOM), and FDI outward funding of physical and organizational expansion of Chinese firms into overseas locations.
Effects of Internationalization to Bilateral Foreign Direct Investment
Child and Rodrigues observed that the mainstream perspective in the international business will internationalize in providing products that they have competitive advantage, because they will secure enough returns to cover for their additional costs and risks. Furthermore, the authors observed the following benefits associated with internalization; ownership advantages, which entail managerial superiority, are applied in a competitive manner in a foreign country. Location advantages are associated with decisions to invest in a foreign market where there are superior markets and/or production opportunities. Internalization increases efficiency through reduction of transactions costs achieved through investing abroad where there are transformations or supporting processes. The influential perspective of late development better explains the potential of a country to develop international links. This has well been established and applied in the developing countries such as Japan, South Korea and China. They had to catch up with the early development countries in technology, knowhow and development of business environment. It is more significant that such companies start from low positions in business mainstream and technology to positions of great power.
CAGE distance framework was developed by Pankaj Ghemawat. CAGE stands for cultural, administrative, geographic and economic distances between different countries of the world. Its gives a broader view of distance since it does not see it as just the location and opportunities. The cultural distances include different languages, ethnicities, religion and social norms. In addition, administrative distances include absence of colonial ties, shared monetary or political association, government policies, institutional weaknesses and political hostilities. On the other hand, geographic distances include lack of common border, size of the country, poor communication and transport infrastructures, different climatic conditions and varying physical remoteness.
Economic distances include varying consumer incomes, different costs and quality in the natural resources, financial resources, infrastructure, inputs and information. In relation, products offered into the market are affected differently. Additionally, in cultural distances, products that are greatly affected include those in linguistic such as TVs and food due to cultural differences. Product features such as sizes, packaging and quality requirements are different in different countries.
In administrative distances, products are greatly affected by the government involvement in production of various products such as electricity. In fact, the government is the one that offers services such as infrastructure. On the other hand, geographic distances influence products through communication and connectivity. Transport, for example, affects perishable and bulky products. Economic distances include variations in demand due to income levels, economies of scale, factors of production such as labor and distribution systems required.
Effects of CAGE Framework to Bilateral Foreign Direct Investment
The framework is applied in determining the differences in physical, cultural and institutional distances that influence trade. It shows that the grater the distance the harder the trade since operations will be constrained. Operations are constrained because countries may lack the specialized intermediaries required for the institutions to work thus creating institution voids. There are various institutions which include financial markets, markets for managerial talent and markets for products. For example, some of the specialized intermediaries for product market include certification agencies, consumer reports, regulatory authorities and extrajudicial dispute resolution services. Thus, if a country does not offer the specialized intermediaries for an investor who is used to them, it will be difficult for them to invest .
Power Distance Index (PPI) Concept
(PPI) concept was developed by Geert Hofstede. It measures the power and wealth distributions among nations, within a nation, business and/or culture. It is based on how people from different cultures view power relationships, for example, superior-subordinate relationship where power is unequally distributed among individuals. People in high power distance readily accept the unequal distribution of power while those in the low power distance question and expect to be answered and participate in decision making. It shows the extent at which citizens of a country submits to the local authorities. Power distance index is higher in countries with higher authoritarian hierarchy and lower in countries or organizations whose authorities work close to those without authority.
Effects of Power Distant Index to Bilateral Foreign Direct Investment
Strict societies and organizations rely mainly on authorities to make most the investment decisions and clearly separate these roles from the subjects unlike those with low power distance index. Thus, it requires more authority for an investor from a country of low power index to invest in a high power distant index. Understanding the power distance and the varying cultural beliefs is crucial since it will highly affect the business context. An individual used to low power index will use the same management negotiation approach to a high power index accustomed individual thus backfiring the business.
Individuals from high power index tend to view power as a reality and believe that everyone has a specific role in the hierarchy of power. However, they often accept autocratic and paternalistic power relations since they are already used to unequal distribution of power. These are likely to invest in all places. Individuals from low power distance expect power relationships to be participatory, democratic and consultative. They believe in equal distribution of power and thus, leaders to them are guides and not supposed to be issuing orders. These individuals find it very difficult in investing in high power distance countries.
Psychic Distance Concept
Psychic is a Greek word “psychikos” referring to individual’s mind and soul. Psychic distance is, therefore, based on human perception and not the organizational and social perspective. According to the definition, psychic distance is the degree to which an individual from one country culture feels comfortable in another country’s culture. In global business, psychic distance encompasses the differences and dissimilarities perceived between the home country and the foreign country. These factors are divided into four categories: languages differences, cultural differences such as values, economic situations such as infrastructure and political and legal systems such as political stability.
Effects Psychic Distance to Bilateral Foreign Direct Investment
It is important to mention that countries only invest in the countries they understand before they proceed to further markets due to market uncertainty. Psychic distance encourages organizations to internationalize as it predicts the adaptations to be made by companies who expand their operations to the other countries.
About the Author
Nancy Bauman is a financial analyst and accounting expert. She is also an expert on business ethics and is constantly participating in university conferences as a member of the Educated Youth Movement. She regularly contributes articles related to business and loans at advanced-writer.com