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Chapter 9: Foreign Market Entry and International Production
An Introduction to International Economics: New Perspectives on the World Economy © Kenneth A. Reinert, Cambridge University Press 2012
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© Kenneth A. Reinert, Cambridge University Press 2012
Analytical Elements Countries Sectors Tasks Firms Factors of production © Kenneth A. Reinert, Cambridge University Press 2012
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© Kenneth A. Reinert, Cambridge University Press 2012
Introduction Exports are just one way that firms can place their products in foreign markets, a process known as foreign market entry Two other means are Contracting Foreign direct investment Contracting and foreign direct investment are two types of international production These are described in Table 9.1 © Kenneth A. Reinert, Cambridge University Press 2012
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Table 9.1: The Foreign Market Entry Menu
Category Mode Characteristics Domestic None Purely domestic firm supplying home market Exporting Indirect Exporting Another firm acts as sales agent Direct Exporting Firm completes export transaction itself Contractual Licensing License to foreign firm to produce abroad Franchising License with conditions to ensure consistency Subcontracting Contract with materials and specifications Investment Joint Venture Jointly owned separate firm Mergers and Acquisitions Purchase of part or whole of foreign firm Greenfield Brand-new production facility © Kenneth A. Reinert, Cambridge University Press 2012
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© Kenneth A. Reinert, Cambridge University Press 2012
Exporting Indirect exporting The home-country firm relies on another firm known as a sales agent or trading company to complete the export transaction Direct exporting The home-country firm takes on the export transaction itself This can include the research, marketing, finance, and logistics requirements of the trade trasaction © Kenneth A. Reinert, Cambridge University Press 2012
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© Kenneth A. Reinert, Cambridge University Press 2012
Contractual Licensing The home-country firm licenses a foreign firm to allow it to use the home-country firm’s production process in the foreign country Franchising The home-country firm licenses a foreign firm to allow it to use the home-country firm’s production process in the foreign country but exerts more control over production and marketing to ensure consistency across foreign markets Subcontracting The home-country firm contracts with a foreign firm to produce a product to certain specifications © Kenneth A. Reinert, Cambridge University Press 2012
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© Kenneth A. Reinert, Cambridge University Press 2012
Investment Joint venture (JV) The home-country firm establishes a separate firm in the foreign country that is jointly-owned with a foreign-country firm Mergers and acquisitions (M&A) The home-country firm buys part (merger) or all (acquisition) of the shares of an already-existing production facility in the foreign country Greenfield investment The home-country firm establishes a brand-new production facility in the foreign country that it fully owns © Kenneth A. Reinert, Cambridge University Press 2012
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Motivation for International Production
Resource seeking Gaining access to natural resources or human resources Market seeking Locating near expected market growth, to better adapt a product to local needs, and to supply intermediate inputs to another firm Efficiency seeking Rationalize the established structure of international production for economies of scale and scope Strategic asset seeking Part of a strategic game among global competitors in oligopolistic sectors © Kenneth A. Reinert, Cambridge University Press 2012
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Strategic Asset Seeking
Insights from Dunning and Lundan (2008) Acquiring or collaborating with another to thwart a competitor from doing so Merging with a foreign rivals to strengthen joint capabilities Acquiring a group of suppliers to corner the market for a particular raw material Gaining access over distribution outlets to better promote its own brand of products Buying out a firm producing a complementary range of goods or services so it can offer its customers a more diversified range of products Joining forces with a local firm in the belief that it is in a better position to secure contracts from the host government © Kenneth A. Reinert, Cambridge University Press 2012
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© Kenneth A. Reinert, Cambridge University Press 2012
Entry Mode Choice Economic view A firm will chose the entry mode that will provide it with the greatest risk-adjusted or expected return on the entry investment Entry mode choice factors include Degree of control Level of resource commitment Dissemination risk the possibility of a foreign partner firm obtaining technology or other know-how from the home-country firm and exploiting it for its own commercial advantage © Kenneth A. Reinert, Cambridge University Press 2012
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Table 9.2: Factors Influencing Choice of Foreign Market Entry Mode
Source: Hill, Hwang and Kim (1990) Mode Degree of Control Level of resource commitment Degree of dissemination risk Trade Low Contractual High Investment- Joint Venture Medium Investment- M&A or greenfield © Kenneth A. Reinert, Cambridge University Press 2012
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© Kenneth A. Reinert, Cambridge University Press 2012
Entry Mode Choice If a firm’s most important concern was Degree of control over the production and marketing process Lead the firm towards an investment mode of foreign market entry based on a subsidiary obtained either through greenfield or acquisition investment Limiting resource commitment to low levels Consider either trade or contractual modes of foreign market entry Low degree of dissemination risk Either trade or investment via a subsidiary would be the preferred mode of entry In most instances, firms have more than one primary concern © Kenneth A. Reinert, Cambridge University Press 2012
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The Rise of Multinational Enterprises and International Production
Early MNEs were part of the colonization efforts during the 16th and 17th centuries Included state-supported trading companies such as the British East India Company, the Dutch East India Company, and the Royal African Company Known as the age of merchant capitalism Industrial revolution in the 19th century led to industrial capitalism British-based MNEs operating in India, China, Latin America, and South Africa Involved in mining, plantation agriculture, finance, and shipping Japan became involved in MNE activity after the Meiji Restoration © Kenneth A. Reinert, Cambridge University Press 2012
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The Rise of Multinational Enterprises and International Production
In the 20th century, industrial production grew more capital intensive Role of the production line and associated economies of scale grew more important Era of industrial capitalism gave way to managerial capitalism or Fordism Center of innovative economic activity moved from Europe to the United States Firm size increased Business success became based on the ability to coordinate growing sets of complementary activities © Kenneth A. Reinert, Cambridge University Press 2012
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The Rise of Multinational Enterprises and International Production
Depression that began in 1929 and the Second World War hurt most forms of international economic activity Post-war recovery further strengthened the role of US-based MNEs Technological advantage of US-based MNEs during the early post-war period was the point of reference of the product life cycle theory Production is confined to the home base MNE during the early phases of product life cycle During later phases production can move to subsidiaries in foreign countries in order to take advantage of lower labor costs © Kenneth A. Reinert, Cambridge University Press 2012
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The Rise of Multinational Enterprises and International Production
The 1970s had the rise of industrial output in the newly industrializing countries (NICs) of East Asia Especially Japan, Taiwan, and South Korea Many see this as new economic era known as post-Fordism or Toyotism Economies of scale have been replaced by flexibility as the progressive element in manufacturing and the use of information and communication technology (ICT) to control production processes Rise of industrial output was followed by a rise in FDI on the part of East-Asian based MNEs Especially those based in Japan © Kenneth A. Reinert, Cambridge University Press 2012
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© Kenneth A. Reinert, Cambridge University Press 2012
Table 9.3: Leading Sources of World FDI (percent of global, outward stocks) Source 1960 1980 1990 2000 2010 United States 47 43 24 22 United Kingdom 18 16 13 15 8 Germany 1 9 7 France 6 4 Japan 11 5 China Brazil All Developing NA 3 14 © Kenneth A. Reinert, Cambridge University Press 2012
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© Kenneth A. Reinert, Cambridge University Press 2012
Table 9.4: Leading Destinations of World FDI (percent of global, inward stocks) Destination 1980 1990 2000 2010 United States 16 20 22 18 United Kingdom 12 10 8 6 Germany 7 5 4 France Japan 1 China 3 Brazil 2 All Developing 26 27 30 31 © Kenneth A. Reinert, Cambridge University Press 2012
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FDI and Comparative Advantage
What difference does FDI make to the comparative advantage model of Chapter 3? This is considered in Figure 9.1 An FDI flow from Japan to Vietnam changes the relative factor/resource endowments of both countries Japan becomes less capital abundant Vietnam becomes more capital abundant These changes shift the PPFs of the two countries © Kenneth A. Reinert, Cambridge University Press 2012
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Figure 9.1: FDI and Comparative Advantage between Vietnam and Japan
© Kenneth A. Reinert, Cambridge University Press 2012
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FDI and Comparative Advantage
Vietnam’s PPF shifts out in a manner biased towards the capital intensive good Japan’s PPF shifts in biased away from the capital intensive good These changes lessen the strength of comparative advantage FDI can therefore be a substitute for trade In other more specific cases, however, FDI can be a complement to trade © Kenneth A. Reinert, Cambridge University Press 2012
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