Copyright ©2002, South-Western College Publishing International Economics By Robert J. Carbaugh 8th Edition Chapter 10: International Factor Movements and Multinational Enterprises

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 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 Cost ($) AC Foreign direct investment A-B Subsidiary A-B Canadian brewery

Carbaugh, Chap Choice between licensing and FDI Per unit cost AVC Canada Foreign direct investment AVC Subsidiary AFC Subsidiary ATC Subsidiary E

Carbaugh, Chap Multinational enterprises International Trade Theory and Multinational Enterprise  Carbaugh: Trade (exports) and FDI as substitutes  Graham: Evidence for US manufacturing MNE’s that exports and FDI are complements  Role of intrafirm trade  Role of principle of comparative advantage

Carbaugh, Chap Multinational enterprises Japanese Auto Transplant Factories  FDI to create a production subsidiary  Reasons  Sell vehicles ‘made in America’  Escape export restraints agreed to in Japan  Japanese market reaching saturation  Avoid yen-dollar fluctuations  Job classification issue  Parts issue

Carbaugh, Chap Multinational enterprises Joint Ventures  Distinct from a merger that creates a new business  Two companies combine skills and assets  Goals: share production, research, product marketing and distribution  Examples: General Motors and Toyota (auto), Honeywell and Mitsubishi (information systems), Corning and Siemens (optical cable)

Carbaugh, Chap Multinational enterprises International joint ventures -forms  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

Carbaugh, Chap Multinational enterprises Problems with joint ventures  Separate organizations retained  Divided control over decision-making  Combining different corporate cultures  Change in corporate goals and personnel

Carbaugh, Chap Multinational enterprises Welfare effects – International JV  Welfare gains  Expand productive capacity  Enter new markets  Cost reductions  Welfare losses  Reduced competition  Enhanced market power

Carbaugh, Chap Welfare effects - International JV Price (thous. $) Demand = price MR Multinational enterprises MC 0 = ATC 0 a b c A B d Sony Auto Co. American Auto Co. JV Company

Carbaugh, Chap Multinational enterprises Sources of Conflict  Employment  M&A vs. greenfield  Management  Home country concerns  Technology transfer  Demonstration effect  Competition effect  The case of China

Carbaugh, Chap Multinational enterprises Sources of Conflict (cont.)  National sovereignty  Tax evasion  Political influence  Embargoes  Balance of payments  Capital movements  Exports  Earnings

Carbaugh, Chap Multinational enterprises Sources of Conflict (cont.)  Taxation  Foreign tax credits for FDI  Tax deferrals for retained foreign earnings  Transfer pricing  Profits reported in low-tax countries  Underprice exports to low-tax country  Overprice exports to high-tax country  ‘Arms length’ principle