Copyright ©2004, South-Western College Publishing International Economics By Robert J. Carbaugh 9th Edition Chapter 10: International Factor Movements and Multinational Enterprises

Carbaugh, Chap Factor movements & multinational enterprises Factor movements  International movement of factors of production (capital, labor) is a substitute for international trade in goods  International capital flows (investment) can substitute for trade in capital-intensive goods  Labor mobility can substitute for trade in labor-intensive goods

Carbaugh, Chap Factor movements & multinational enterprises Multinational enterprises  Various business operations in numerous host countries  Headquarters often far from operations  Stock ownership and management are usually multi-national  Frequently employ vertical integration, horizontal integration, conglomerate structure

Carbaugh, Chap Multinational enterprises Foreign direct investment  A foreign or multinational firm can buy a controlling interest in a local firm  Buy or build new plants or equipment overseas  Shift funds abroad to expand a subsidiary  Reinvest the earnings of a foreign subsidiary

Carbaugh, Chap Multinational enterprises Reasons for foreign direct investment  Demand factors  Serve different local markets  Respond to market competition  Cost factors  Access to key raw materials  Labor costs  Transportation costs  Government policies

Carbaugh, Chap Choice between export and FDI Foreign direct investment

Carbaugh, Chap Choice between licensing and FDI Foreign direct investment

Carbaugh, Chap Multinational enterprises International joint ventures  Two companies can operate a venture in a third country  A foreign firm can work with a local company  A foreign firm can form a venture with a unit of the local government

Carbaugh, Chap Multinational enterprises Reasons for international JVs  Cost sharing - R&D, capital expenditures (in mining and oil, for example)  Avoiding restrictions on foreign ownership of local firms (ensuring local participation)  Forestalling pressure for protectionism  Problems: divided control means success of JV depends on ability of firms to work together

Carbaugh, Chap Effects of an international JV Multinational enterprises

Carbaugh, Chap Multinational enterprises Controversy over multinationals  Employment  Host country may not gain many jobs, foreign managers often brought in; source country worries about losing jobs  Technology transfer  MNEs are reluctant to share technology with host nations; source country worries about giving away advantage

Carbaugh, Chap Multinational enterprises Controversy over multinationals (Cont’d)  National sovereignty  Host country worries about power of MNE to influence affairs; source country worries about ability to regulate MNE activities elsewhere  Balance of payments  MNE investments and profits (internal transfers) have impacts on the payments status of both source and host nations

Carbaugh, Chap Multinational enterprises Controversy over multinationals (Cont’d)  Taxation  Source countries may have difficulty taxing MNE income stemming from foreign operations  Tax rate differences may discourage investment at home  Transfer pricing  Both host and source governments worry that MNEs may illegally manipulate prices paid between subsidiaries to avoid taxes

Carbaugh, Chap Transfer pricing illustrated Multinational enterprises Germany (tax rate 48%) Computer produced by parent firm for $2000. Sold to Irish subsidiary for $2000. German tax paid: $0. Ireland (tax rate 4%) Irish subsidiary resells the same computer to US subsidiary for $2500, earning $500 profit. Irish tax paid: $20. United States (tax rate 34%) US subsidiary sells computer at cost, for $2500. No profit is earned. US tax paid: $0. Irish subsidiary then lends money to US subsidiary for expansion

Carbaugh, Chap International factor movements Migration  Tends to equalize wage rates between countries  Shifts distribution of income between capital and labor  Other concerns:  Fiscal drain from immigration  Brain drain from developing countries  Impact of illegal migration  Wider gulf between skilled and unskilled workers

Carbaugh, Chap Effects of labor migration International factor movements United StatesMexico