International Economics Tenth Edition

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International Economics Tenth Edition CHAPTER T W E L V E 12 International Economics Tenth Edition International Resource Movements and Multinational Corporations Dominick Salvatore John Wiley & Sons, Inc. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Learning Goals: Describe the motivation for international portfolio and direct investments Describe the effects of portfolio investment on investing and host country Understand the reasons for the existence of multinational corporations and the effect on home and host countries Understand the motives and effect of international labor migrations Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Two main types of foreign investments: Introduction International trade and movement of productive resources are substitutes. As with trade, the movement of resources between nations tends to equalize factor returns. Two main types of foreign investments: Portfolio investments Direct investments Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Portfolio Investments Introduction Portfolio Investments Purely financial assets, such as bonds or less than 10% of voting stock, denominated in a national currency. Take place primarily through financial institutions such as banks and investment funds. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Introduction Direct Investments Real investments in factories, capital goods, land and inventories where both capital and management are involved and the investor retains control over use of invested capital. Usually takes form of a firm starting a subsidiary or taking control of another firm. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Some Data on International Capital Flows Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Some Data on International Capital Flows Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Some Data on International Capital Flows Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Some Data on International Capital Flows Both U.S. and foreign portfolio investments and direct investment increased rapidly between 1950 and 2007. The stock of U.S. direct investments in Europe grew much more rapidly than in Canada and Latin America, due to the rapid growth of the E.U. and the U.S. desire to avoid common external tariffs. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Motives for International Capital Flows International Portfolio Investments The basic motive for international portfolio investment is to earn higher returns abroad. Portfolio theory tells us that by investing in securities with yields that are inversely related (like foreign and domestic securities) over time, a given yield can be obtained at a smaller risk, or a higher yield can be earned with the same level of risk for the portfolio as a whole. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Motives for International Capital Flows International Portfolio Investments So a portfolio including both domestic and foreign securities can have a higher average yield and/or lower risk than one containing only domestic securities. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Motives for International Capital Flows Direct Foreign Investments The basic motive for direct foreign investment is to earn higher returns (possibly from higher growth rates abroad, more favorable tax treatment or greater availability of infrastructure) and to diversify risks. Large corporations often have unique product knowledge or managerial skill that could easily and profitably be used abroad and over which the corporation wants to retain direct control. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Motives for International Capital Flows Direct Foreign Investments Horizontal integration is the production abroad of a differentiated product that is also produced at home. Vertical integration (backward) allows a corporation to obtain control of a needed raw material and thus ensure uninterrupted supply at lowest possible cost, or acquire later stages in the production process, or ownership of sales or distribution networks abroad (forward). Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Motives for International Capital Flows Direct Foreign Investments Also done to avoid tariffs and other restrictions that nations impose on imports, or to take advantage of government subsidies encouraging direct foreign investment. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Welfare Effects of International Capital Flows International capital flows increase the efficiency in the allocation of resources internationally and increase world output and welfare. In the year the foreign investment occurs, the foreign expenditures of the investing country increase, causing a balance of payments deficit in the investing country, and an improvement in the host nation’s balance of payments. The investing nation experiences a reduction in tax collections, while the host nation experiences an increase in tax collections. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

FIGURE 12-1 Output and Welfare Effects of International Capital Transfers. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Multinational Corporations Multinational corporations (MNCs) own, control, or manage production and distribution facilities in several countries. Today, MNCs account for about 25% of world output, with intrafirm trade estimated at about one third of total world trade in manufacturing. Most international direct investments are undertaken by MNCs. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Multinational Corporations Reasons for MNCs Integration may increase profits through better control of supply chains. The larger scale of production may allow the firm to better exploit economies of scale. MNCs can better direct production to low cost nations. MNCs can artificially change prices to only show profits in low tax nations (transfer pricing). Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Multinational Corporations Problems in Home Country Loss of domestic jobs to other countries. MNCs may move technology out of the home country reducing the technological advantage of the home country. Transfer pricing may reduce taxable income and tax revenue. Access to foreign markets allows MNCs to circumvent domestic monetary and fiscal policy control. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Multinational Corporations Problems in Host Country MNCs are alleged to dominate their economies. R&D funds are siphoned off to the MNC’s home nation, keeping host nation technologically dependent. MNCs may extract from host nations most of the benefits of their investment, either through tax and tariff benefits or tax avoidance. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Motives for and Welfare Effects of International Labor Migration Benefits of Labor Migration The opportunity to earn higher real wages Greater educational and job opportunities Escape from political oppression or conflict Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Motives for and Welfare Effects of International Labor Migration Monetary Costs of Labor Migration Expenditures for transportation and fees Lost wages during relocation and job search Non-Monetary Costs of Labor Migration Separation from relatives, friends, and familiar surroundings Need to learn new customs and/or new language Risks involved in finding a job, housing, etc. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Motives for and Welfare Effects of International Labor Migration Effects on recipient country Increased ability to produce The increase in the labor force increases productive ability by expanding one of the factors of production. The workers may possess high levels of skills that enhance the recipient country’s human capital. Dislocation of native workers competing with the new entrants to the labor force Increased unemployment Lower wages Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Motives for and Welfare Effects of International Labor Migration Effects on source country Loss in domestic productive ability The decrease in the labor force decreases the nation’s ability to produce. This concern is reduced if the source country suffers from significant unemployment. The loss of skilled workers – brain drain – reduces human capital. This concern is exacerbated by the resources expended in training such workers prior to migration. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Motives for and Welfare Effects of International Labor Migration Effects on the source country Increased domestic wages The decline in the number of workers should aid in driving up wages in the source country. Again, this effect is reduced if the country suffers significant unemployment. Source of new foreign earnings: repatriated income Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

FIGURE 12-2 Output and Welfare Effects of International Labor Migration. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Case Study 12-1 Fluctuations in Foreign Direct Investment Flows to the United States Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Case Study 12-2 The Stock of Foreign Direct Investments Around the World Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Case Study 12-3 The World’s Largest Non-Petroleum Industrial Corporations Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Case Study 12-4 Employment of U.S. MNCs Abroad Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Case Study 12-5 U.S. Immigration and Debate Over Immigration Policy Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Appendix: The Transfer Problem Long term capital movements must be accompanied by a transfer of real resources from the lending country to the borrowing country. See further discussion of the transfer problem in Section A17.2 Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Copyright 2013 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in section 117 of the 1976 United States Copyright Act without express permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information herein. Case studies and tables. Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.