Economics Essay

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INTERNATIONAL

ECONOMICS SEVENTEENTH EDITION

ROBERT J. CARBAUGH

Chapter 9

International

Factor

Movements

and

Multinational

Enterprises

Chapter Outline (1 of 2)

The Multinational Enterprise

Motives for Foreign Direct Investment

Supplying Products to Foreign Buyers: Whether to Produce Domestically or Abroad

Country Risk Analysis

Chapter Outline (2 of 2)

International Trade Theory and Multinational Enterprise

Foreign Auto Assembly Plants in the U.S.

International Joint Ventures

Multinational Enterprises as a Source of Conflict

International Labor Mobility: Migration

The Multinational Enterprise (1 of 6)

The Multinational Enterprise (MNE)

• Operate in many host countries

• Often conduct research and development

(R&D) activities, in addition to manufacturing,

mining, extraction, and business-service

operations

• Often directed from a company planning

center distant from host country

The Multinational Enterprise (2 of 6) Table 9.1

The World’s Largest Corporations, 2016

Firm Headquarters Revenues ($ billions)

Walmart Stores United States 482.1

State Grid China 329.6

China National Petroleum China 299.3

Sinopec Group China 294.3

Royal Dutch Shell Netherlands 272.1

Exxon Mobil United States 246.2

Volkswagen Germany 236.6

Toyota Motor Japan 236.6

Apple United States 233.7

BP United Kingdom 226.0

Source: From “The 2016 Global 500,” Fortune, available at http://www.fortune.com.

The Multinational Enterprise (3 of 6)

• The Multinational Enterprise (cont.)

• Multinational stock ownership

• Multinational company management

• High ratio of foreign sales to total sales

• Types of integration:

• Vertical integration:

• Parent MNE establishes foreign subsidiaries to produce intermediate goods or inputs that go into the

production of a finished good

The Multinational Enterprise (4 of 6)

• Types of Integration (cont.)

• Horizontal integration

• Parent company produces commodity in source

country

• Sets up subsidiary to produce identical product in

host country

• Conglomerate integration

• Diversify into nonrelated markets

The Multinational Enterprise (5 of 6)

• Foreign direct investment by parent

company

• Obtains sufficient common stock in a foreign

company to assume voting control

• Constructs new plants and acquires

equipment overseas

• Shifts funds abroad to finance expansion of its

foreign subsidiaries

• Earnings of foreign subsidiaries reinvested in

plant expansion

The Multinational Enterprise (6 of 6) Table 9.2

Direct Investment Position of the United States on a Historical Cost Basis, 2015*

U.S. DIRECT INVESTMENT ABROAD FOREIGN DIRECT INVESTMENT IN U.S.

Country Amount

(billions of dollars) Percentage Amount

(billions of dollars) Percentage

Canada 352.9 7.0 269.0 8.6

Europe 2,949.2 58.5 2,162.8 69.0

Latin America 847.6 16.8 118.8 3.8

Africa 64.0 1.3 0.7 0.0

Middle East 48.5 1.0 18.5 0.1

Asia and Pacific 778.3 15.4 564.4 18.5

5,040.5 100.0 3,134.2 100.0

*Historical cost valuation is based on the time the investment occurred, with no adjustment for price changes.

Source: From U.S. Department of Commerce, U.S. Direct Investment Position Abroad and Foreign Direct Investment Position in the United States on a Historical-Cost Basis, available at http://www.bea.doc.gov/. See also U.S. Department of Commerce, Survey of Current Business, Washington, DC, Government Printing Office.

Motives for Foreign Direct Investment (1 of 3)

Foreign Direct Investment (FDI)

• Motivated by higher rates of return on

investment

• Leads to economic growth and job creation

• Generates spillovers

• Improved management and better technology

• Higher average labor productivity

• Higher wages

• Stimulates exports of capital goods

Motives for Foreign Direct Investment (2 of 3)

• Demand Factors

• New markets and sources of demand

• Tap foreign markets that cannot be

maintained adequately by export products

(licensing rights)

• Parent company ⎯ productive capacity already sufficient to meet domestic demand

• Market competition

• Direct exporting

Motives for Foreign Direct Investment (3 of 3)

• Cost Factors

• Reductions in production costs

• Acquisition of essential raw materials

• Lower labor costs

• Decreased transportation costs

• Government policies

• Economies of scale

• Direct exporting – foreign demand is small

• Licensing agreement/FDI – demand is large

Supplying Products to Foreign Buyers:

Whether to Produce Domestically or Abroad (1 of 4)

Direct Exporting versus Foreign Direct

Investment/Licensing

• Economies of Scale (See Fig 9.1)

• Small Demand/Output – Direct Exports

• Large Demand/Output – FDI/Licensing

• Low Transportation Cost – Direct Exports

• High Transportation Cost – FDI/Licensing

• Low Trade Restrictions – Direct Exports

• High Trade Restrictions – FDI/Licensing

Supplying Products to Foreign Buyers:

Whether to Produce Domestically or Abroad (2 of 4) Figure 9.1

Supplying Products to Foreign Buyers:

Whether to Produce Domestically or Abroad (3 of 4)

• Foreign Direct Investment versus

Licensing

• Decision to establish foreign operations

through Direct Investment or Licensing

depends on (see Fig. 9.2)

• Capital used in production

• Size of foreign market

• Fixed cost of establishing overseas facility

Supplying Products to Foreign Buyers:

Whether to Produce Domestically or Abroad (4 of 4) Figure 9.2

Country Risk Analysis (1 of 4)

Country Risk Analysis

• Political risk analysis

• Assesses political stability of country

• Government stability, corruption, domestic conflict,

religious tensions, and ethnic tensions

• Financial risk analysis

• Investigates country’s ability to finance its debt

obligations

• Foreign debt as percentage of GDP, loan default,

and exchange rate stability

Country Risk Analysis (2 of 4)

• Country Risk Analysis (cont.)

• Economic risk analysis

• Determines country’s current economic

strengths and weaknesses

• Rate of growth of GDP, per capita GDP, inflation

rate

• Composite country risk rating

• Overall assessment of risk of doing business

in country

Country Risk Analysis (3 of 4)

• Country Risk Analysis (cont.)

• International Country Risk Guide

• Political risk factors – weighting of 50%

• Financial and economic risk factors – 25% each

• Low risk: 80–100 points

• Moderate risk: 50–79 points

• High risk: 0–49 points

Country Risk Analysis (4 of 4) Table 9.3

Selected Country Risks Ranked by Composite Ratings, 2016

Country Composite Risk Rating (100 Point Maximum)

Switzerland 88.0 Very Low Risk

Singapore 86.8

Germany 84.3

United States 79.3

China 71.3

Brazil 63.3

Russia 62.5

Ukraine 55.3

Zimbabwe 54.5

Sudan 48.3 Very High Risk

Source: From Political Risk Services, International Country Risk Guide, available at https://www.prsgroup.com/ FreeSamplePage.aspx/.

International Trade Theory and

Multinational Enterprise (1 of 2)

Conventional trade model

• Movement of merchandise among nations

• Goods are exchanged between independent

organizations

• On international markets

• At competitively determined prices

International Trade Theory and

Multinational Enterprise (2 of 2)

• Multinational-enterprise analysis

• International movement of factor inputs

• Aggregate welfare of both source and host

countries is enhanced

• Vertically diversified companies

• Subsidiaries manufacture intermediate and

finished goods

• Sales can be intrafirm

• Value may be determined by factors other than

competitive pricing system

Foreign Auto Assembly Plants

in the United States (1 of 3)

Transplants – direct investment in U.S.-

based assembly facilities

Benefits to Japan include

• Silencing critics who say autos must be built

in U.S.

• Avoiding import barriers of U.S.

• Gaining access to expanding markets

• Providing hedge against changes in exchange

rates between U.S. dollar and Japanese yen

Foreign Auto Assembly Plants

in the United States (2 of 3) Table 9.4

Selected Foreign Auto Assembly Plants in the United States

Plant Name/Parent Company Location

Honda of America, Inc. (Honda) Marysville, Ohio; Lincoln, Alabama; East Liberty, Ohio; Greensburg, Indiana

Toyota Motor Manufacturing, USA, Inc. (Toyota) Georgetown, Kentucky; Huntsville, Alabama; Princeton, Indiana; San Antonio, Texas; Buffalo, West Virginia; Blue Springs, Mississippi

Nissan Motor Manufacturing Corp. (Nissan) Smyrna, Tennessee; Decherd, Tennessee; Canton, Mississippi

Mazda Motor Manufacturing, USA, Inc. (Mazda) Claycomo, Missouri

Volkswagen, USA, Inc. (Volkswagen) Chattanooga, Tennessee

Foreign Auto Assembly Plants

in the United States (3 of 3)

• Expectations of Japanese Transplants in U.S.

• Would generate jobs

• Expand consumer choice

• Create demand for auto parts industry in U.S.

• Transfer technology from Japan to U.S.

• What actually happened

• Created fewer jobs than expected

• Imported parts from Japan rather than buying locally

• Contributed to U.S. automotive trade deficit

International Joint Ventures (1 of 6)

International joint ventures

• Business organization established by two or

more companies

• Combine their skills and assets

• Limited objective (research or production)

• Short-lived

• Multinational in character

• Several domestic and foreign companies

• Creation of new business firm

International Joint Ventures (2 of 6)

• International joint ventures (cont.)

• Types of International Joint Ventures

• Joint venture by two businesses that conduct

business in third country

• Joint venture with local private interests

• Joint venture with participation by local

government

International Joint Ventures (3 of 6)

• International joint ventures (cont.)

• Justifications for joint ventures

• Some functions too costly for one company to

absorb by itself

• Some governments place restrictions on foreign

ownership of local businesses

• To prevent excessive political influence

• To minimize dividend transfers abroad

• Forestalling protectionism against imports

International Joint Ventures (4 of 6)

• Welfare Effects

• Advantages of joint ventures

• Productivity and welfare gains

• Increased productive capacity and additional

competition

• Entrance into new markets that neither parent

could have entered individually

• Cost reductions that would have been

unavailable if each parent performed same

function separately

International Joint Ventures (5 of 6)

• Welfare Effects (cont.)

• Disadvantages of joint ventures

• Cumbersome organization

• Divided control

• Different objectives, corporate cultures, and ways of

doing things

• Deadlocks in decision making

• Negotiations involve hierarchical command

• Can lead to welfare losses (market-power effect)

International Joint Ventures (6 of 6) Figure 9.3

Multinational Enterprises

as a Source of Conflict (1 of 5)

Employment

• Effects on employment

• Recipient country

• Employment increases

• Source country

• Employment declines in short term

• Other industries – foreign sales rise over time

Caterpillar Bulldozes Canadian Locomotive

Workers

-Lower worker pay; non-unionized

Multinational Enterprises

as a Source of Conflict (2 of 5) • Technology Transfer

• Technology transfer facilitated through

demonstration effect and competition effect

• Increases productivity and competitiveness of

recipient nations

• Donor nations may view it negatively because it

may decrease export potential and cause job loss

• General Electric’s trade-off for entry into the

Chinese market: short-term sales for long-

term competition

• Boeing Transfers Technology to China

Multinational Enterprises

as a Source of Conflict (3 of 5)

• National Sovereignty

• Many nations fear presence of MNEs results

in loss of national sovereignty • MNEs may affect economic and other policies of

host and source governments

• May be able to shift profits overseas and evade

taxes of host country

• Political influence of MNEs problematic

• Example: Chile and MNEs’ influence on election of

president

• Foreign subsidiary of MNE may trade with nation

against which home country has embargo

Multinational Enterprises

as a Source of Conflict (4 of 5)

• Balance of payments

• Positive contribution

• MNE typically purchases capital and other

equipment from home country

• Inflow of income generated by overseas operations

• Earnings of overseas affiliates, interest and dividends,

and fees and royalties

• Negative contribution

• Short-term outflow of capital

Multinational Enterprises

as a Source of Conflict (5 of 5)

• Transfer Pricing

• Pricing of goods within MNE

• May be arbitrary and unrelated to costs incurred or

to operations carried out

• Choice of transfer prices affects division of total

profit among parts of company and thus influences

overall tax burden

International Labor Mobility:

Migration (1 of 12)

United States • Favorite target for international migration

• Described as melting pot of the world

• Western Europe the major source of immigrants for

U.S.⎯1820–2012

• Germany, Italy, United Kingdom

• In recent years, large number of Mexican and Asian

immigrants

Migrants–motivated by • Better economic opportunities

• Noneconomic factors: politics, war, religion

International Labor Mobility:

Migration (2 of 12) Table 9.5 U.S. Immigration 1820–2015

Period Number (thousands)

1820–1840 743

1841–1860 4,311

1861–1880 5,127

1881–1900 8,934

1901–1920 14,531

1921–1940 4,636

1941–1960 3,551

1961–1980 7,815

1981–2000 16,433

2001–2015 15,652

Source: From U.S. Department of Homeland Security, Office of Immigration Statistics, Yearbook of Immigration Statistics, 2012, available at http://www.uscis.gov/graphics/shared/statistics/yearbook/. See also U.S. Department of Commerce, Bureau of the Census, Statistical Abstracts of the United States, Washington, DC, Government Printing Office, available at www.census.gov\\statab\\.

International Labor Mobility:

Migration (3 of 12)

• The Effects of Migration

• Mexican immigration to U.S.

• Workers migrate from uses of lower productivity to

higher productivity

• World output expands

• U.S. as whole benefits from immigration

• Income gain is sum of losses of native U.S. workers,

gains by Mexican immigrants, and gains by U.S. capital

owners

• Mexican labor supply decreases, increasing wages

• U.S. labor supply increases, decreasing wages

International Labor Mobility:

Migration (4 of 12)

• The Effects of Migration (cont.)

• Mexican workers immigrate to the U.S. (cont.)

• Effect of Labor Mobility is to equalize wages

• Redistribute income from labor to capital in the

United States

• Redistribute income from capital to labor in Mexico

International Labor Mobility:

Migration (5 of 12) Figure 9.4

International Labor Mobility:

Migration (6 of 12)

• Immigration as an Issue

• Domestic labor groups prefer restrictions on

immigration

• Domestic manufacturers favor unrestricted

immigration as source of cheap labor

• Drain on government resources

• Long-term calculations: immigrants make a net-

positive contribution to public coffers

International Labor Mobility:

Migration (7 of 12)

• Immigration as an Issue (cont.)

• Developing nations fear brain drain

• Emigration of highly educated and skilled people

from developing nations to industrial nations

• Limiting the growth potential of developing nations

• Guest workers

• Temporary migration, as workers are needed

• Illegal migration

International Labor Mobility:

Migration (8 of 12)

• Immigration as an Issue (cont.)

• Immigrants make net-positive contribution

• Diversify economy

• Contribute to economic growth

• Lower prices for consumers

• Domestically produce a wider variety of goods

• Increase supply of labor in economy

• Similar skills – lower wage

• Complementing skills – higher wage

• Human capital formation costs – native country

• Contribution to social security

International Labor Mobility:

Migration (9 of 12)

• Does Canada’s Immigration Policy Provide a

Model for the U.S.?

• Goal of Canadian immigration system to

encourage youthful, bilingual, high-skill

immigration in order to build human capital within

Canada’s aging labor force

• Canada treats foreign workers not as foes but

friends whose labor & skills are essential

• Canada currently solicits immigrants from more

than 200 countries of origin, especially China,

India, and the Philippines

International Labor Mobility:

Migration (10 of 12)

• Does Canada’s Immigration Policy Provide a

Model for the U.S.? (cont.)

• Canada needs immigrants for economic

development • Immigration program run by provincial & federal

governments

• A province can select whomever it wants; federal

government’s role limited to security, criminal, and

health check of foreigners

• Canada – 2/3 of permanent visas granted to fill

economic needs

• In U.S., by contrast, 2/3 granted for family reunions

International Labor Mobility:

Migration (11 of 12)

• Does Canada’s Immigration Policy Provide a

Model for the U.S.? (cont.) • Multiculturalism is key ingredient of Canadian

national identity

• Canadians see immigration as adding to social fabric

of country

• Canada has become immigrant country

• Foreign-born population of 20%

• U.S. foreign-born population is 13%

• Immigration program revised to place more emphasis

on job skills and fluency in French or English

International Labor Mobility:

Migration (12 of 12)

• Does Canada’s Immigration Policy Provide

a Model for the U.S.? (cont.) • In 2013, Canada began overhaul of immigration

program, to address increasing economic division

between locals and immigrants

• New system considers

• whether immigrants have employment arranged in Canada

• whether they have skills in demand

• immigrants’ adaptability, e.g., time spent previously in

Canada, fluency in English or French

• Remains to be seen how revised system will play out