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International Economics 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. CHAPTER T W E L V E 12
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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 (skip) Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
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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.
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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. Equity investment vs. bond investment Examples of equity investment: Examples of bond investment: Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
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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 (greenfield investment) or taking control of another firm through mergers or acquisitions (cross-border M&A). Examples of greenfield investment: Examples of cross-border M&A: Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
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Some Data on International Capital Flows Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
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2. Some Data on International Capital Flows Figure 1. Trend of East Asia’s Total Portfolio Investment in the U.S. 2002-2011 Source: Calculated by HHLEE using US Treasury Department’s TIC Database Blue-China; Red- Japan; Green-EA developing countries
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2. Some Data on International Capital Flows Figure 2. Trend of East Asia’s Equity Investment in the U.S. 2002-2011 Blue-China; Red- Japan; Green-EA developing countries Source: Calculated by HHLEE using US Treasury Department’s TIC Database
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2. Some Data on International Capital Flows Figure 3. Trend of East Asia’s Long-term Securities (Bond) Investment in the U.S. 2002-2011 Blue-China; Red- Japan; Green-EA developing countries Source: Calculated by HHLEE using US Treasury Department’s TIC Database
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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.
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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.
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Motives for International Capital Flows Foreign Direct 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.
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Motives for International Capital Flows Foreign Direct 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.
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© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor Vertical integration: offshoring
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Motives for International Capital Flows Foreign Direct 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.
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16 Resource Transfer Stable source of foreign capital Advanced technology Advanced management skills Creation of employment opportunities True with greenfield FDI Not so true with M&E Stronger competition Domestic market becomes more efficient with stronger competition among firms Positive effects on Balance of Payment (BOP) Capital inflow with initial FDI When the goods/services produced by the FDI substitute for imported goods/services When the goods/services produced by the FDI are exported to another country Economic growth To some extent, FDI may help the economy grow faster 4. Welfare Effects of International Capital Flows: Benefits of FDI
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17 Adverse effects on competition Foreign firms (MNEs) may have too much power and kill off competition Adverse effects on BOP After initial inflow of capital, subsequent outflow of capital from the earnings of the FDI Import inputs from abroad for the foreign firms Weakening of national sovereignty Possible loss of economic independence as some decisions that affect the host country’s economy may be made by a foreign company that has no real commitment to the host country 4. Welfare Effects of International Capital Flows: Costs of FDI
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Multinational Corporations Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc. Multinational corporations (MNCs) own, control, or manage production and distribution facilities in several countries. Today, MNCs account for about 25% of world output, with intra-firm trade estimated at about one third of total world trade in manufacturing. Most international direct investments are undertaken by MNCs.
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Multinational Corporations Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc. 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.
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Multinational Corporations Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc. 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.
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Multinational Corporations Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc. 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.
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Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc. What is international product fragmentation? The geographic separation of activities involved in producing a good (or service) across two or more countries’. Alternative terms: vertical specialization, slicing the value chain, international production sharing outsourcing, or trade in intermediate goods. Product Fragmentation and Foreign Outsourcing
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24 What is importance of international product fragmentation? Reinforces the linkage between trade and FDI policies. Makes a strong case for the removal/harmonisation of non- border policy barriers with a view to enhancing gains from global integration Has implications for the debate on regional versus multilateral (global) economic integration approaches to international trade policy. Product Fragmentation and Foreign Outsourcing
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■ A value chain (VC) is a set of activities that a firm operating in a specific industry performs in order to deliver a valuable product or service for the market. (Wikipedia) ■ The concept comes from business management and was first described by Michael Porter in his 1985 best-seller, Competitive Advantage: Creating and Sustaining Superior Performance. (Wikipedia) ■ Global value chain (GVC) emerged in the late 1990s as multinational enterprises (MNEs) or transnational corporations (TNCs) increased overseas investment. ■ To enhance efficiency, MNEs locate “R&D, design, production of parts, assembly, marketing" activities in different countries around the globe (i.e. international fragmentation of production). ■ East Asia and Europe have been particularly at the center of GVC. 1. Global value chain (GVC) – The concept
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■ Labour-intensive tasks such as assembly in GVCs take place primarily in developing economies with abundant labour, while knowledge-intensive activities such as R&D and design and marketing are concentrated in developed economies. 1. Global value chain (GVC) – The concept
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■ Trade in GVCs involves extensive flows of intermediate goods and services. 2. GVC and trade in intermediate goods
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How conventional trade statistics is calculated Total value of all (final and intermediate) goods passing through customs Problems with conventional trade statistics It is exaggerated because of double counting. When a country exports, only domestic value-added contributes to GDP. A new measure: Trade in Value Added (TiVA) In May 2013, the OECD and the WTO released its first version of Trade in Value Added (TiVA) database, integrating national input-output tables with trade data. It includes “decomposition of gross exports by industry into their domestic and foreign content”, “bilateral trade balances based on flows of value added embodied in domestic final demand”, etc. 3. Conventional trade statistics and GVCs
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■ Global value added in trade 3. Conventional trade statistics and GVCs
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■ Domestic valued added content of gross exports, % Source: OECD-WTO TiVA database 4. An Anatomy of GVCs using TiVA
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■ GVC Participation rate is higher in countries with more FDI stock. 5. Reasons for Fast Expansion of GVCs
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