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ECO 310, Chapter 8

by: Tori Notetaker

ECO 310, Chapter 8 Eco 310

Tori Notetaker
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These notes are a brief outline of the key concepts from chapter 8
Issues in the Global Economy
Mary Reed
Class Notes
ECO 310, MSU, Global Economics
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This 7 page Class Notes was uploaded by Tori Notetaker on Wednesday March 30, 2016. The Class Notes belongs to Eco 310 at Murray State University taught by Mary Reed in Spring 2016. Since its upload, it has received 40 views. For similar materials see Issues in the Global Economy in Economcs at Murray State University.

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Date Created: 03/30/16
Chapter 8 Key Terms Key Concepts (from text and lecture) Recognize current trends regarding foreign direct investment (FDI) in the world economy.  FDI in the World Economy o Trends in FDI  Over the past 35 years the flow and stock of FDI in the world economy has increased significantly  By 2012 the stock of FDI was ~$22.8 trillion and affiliates of multinationals accounted for one-third of all cross- border trade  Why has FDI grown faster than world trade or output?  Firms fear protectionist pressures  It has been driven by political and economic changes in developing nations  Globalization of the world economy o The Direction of FDI  Since the 1980’s the U.S. has been an attractive target for FDI from nations such as Japan, Great Britain, Germany, Holland and France  The U.K. and France are the largest recipients of inward FDI  FDI is also moving to target developing nations such as those in the former Soviet Union and Southeast Asia.  As a result of political unrest, armed conflict, and frequent changes in economic policy, Africa is unable to attract much FDI o The Source of FDI  The U.S., U.K., France, Germany, and the Netherlands  Largest source countries for FDI post WWII  Accounted for 60% of FDI outflows between 1998-2012  The Chinese have started to be noticed as major foreign investors  Originally investing in African countries for raw materials, but are now looking towards more developed nations o The Form of FDI: Acquisitions VS Greenfield Investments  1998-2012 40%-80% of FDI inflows were mergers and acquisitions (UN)  In developing nations, one-third or less of FDI are cross- border mergers and acquisitions  Mergers and acquisitions are quicker than greenfield investments  Foreign firms are acquired because those firms have valuable strategic assets  Brand loyalty, customer relationships, trademarks or patents, distribution systems, production systems, etc.…  Firms make acquisitions to increase the efficiency of the acquired unit by transferring capital, technology, or management skills Explain the different theories of FDI.  Theories of Foreign Direct Investment o Why FDI?  “Why do firms go to the trouble of establishing operations abroad through foreign direct investment when exporting and licensing are available for exploiting the profit opportunities in a foreign market?  FDI is expensive, costs of establishing foreign facilities  FDI is risky, problems of doing business in a different culture  Limitations of Exporting  Transportation costs o Products become unprofitable to ship over long distances when they have a low value-to-weight ratio  Trade barriers o Import tariffs o Quotas o Imposed by foreign governments increase the costs of exporting industries, increasing Licensing and FDI attractiveness  Trade barriers do not have to be in effect for FDI to be the more attractive option, it’s usually desired to reduce the threat of them coming into place  Limitations of Licensing  Internalization theory; major drawbacks of licensing o “Licensing may result in a firm’s giving away valuable technological know-how to a potential foreign competitor.” o “Licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability.” o “When a firm’s competitive advantage is based more on management, marketing, and manufacturing than its products, such capabilities are often not amenable to licensing.”  FDI is more profitable then licensing when: o The firm has valuable know-how than can’t be protected by a licensing contract o The firm needs tight control over a foreign entity o “When a firms skills and know-how are not amenable to licensing.” o The Pattern of Foreign Direct Investment  Strategic Behavior  FDI flows are a reflection of strategic rivalry o F.T. Knickerbocker looked are the connection between this idea and Oligopoly  Competitive features  What one firm does will have an effect on major competitors, forcing a response  “by cutting prices, one firm can take market share away from its competitors, forcing them to make similar price cuts  An oligopoly leads to imitative behavior  Multipoint competition o Firms will match each other’s moves (like in chess) to ensure their rival doesn’t gain a commanding position in a market o The Eclectic Paradigm  Theorized by John Dunning  Location-specific advantages explain both the rationale and direction of FDI  “Because labor is not internationally mobile, according to Dunning it makes sense for a firm to locate production facilities in those countries where the cost and skills of local labor are most suited to its particular production processes.” o Same not goes for locations with resources that are domestically lacking Understand how political ideology shapes a government’s attitudes toward FDI.  Political Ideology and FDI o The Radical View  Traced back to Marxist political and economic theory, argues that MNE’s are an instrument of imperialist domination and exploit host countries, keeping less developed countries dependent on them and maintain that they stay undeveloped.  Up until the early 1990’s the radical position was largely favored.  3 reasons for the change: o Collapse of communism in Eastern Europe o Those who embraced the radical position had poor economic performance and believed that FDI could help them grow in technology and jobs, forcing economic growth o The other countries were doing pretty well that weren’t following the radical view o The Free Market View  Argues that international production should be guided by Comparative Advantage and that MNE’s are instruments for dispersing goods and services to the most efficient locations globally.  Suggests that FDI benefits both the “source country” and the “host country” o Pragmatic Nationalism  FDI has benefits  Can benefit a host country by bringing capital, skills, technology and jobs  Those benefits also have costs o Shifting Ideology  Many countries are shifting towards a free market policy  Former countries of the Soviet Union, Socialist Africa, India, Japan, South Korea, Italy, Spain, and Latin America  Although there is also a hostile shift towards FDI in countries like Venezuela and Bolivia which could put lower trade barriers and cross-border investments at risk if they spread. Describe the benefits and costs of FDI to home and host countries  Benefits and Costs of FDI o Host-Country Benefits  Resource-Transfer Effects  FDI boots economic growth through providing a country resources like: Capital, technology, and management  Employment Effects  FDI creates jobs in the host-country that wouldn’t be there otherwise  Direct Effects on employment o When foreign MNE’s employ citizens from the host country  Indirect Effects on employment o Jobs created in local suppliers that also increases spending by employees of the MNE  Balance-Of-Payments Effects  A trade deficit is when a country is importing more goods than it’s exporting o Governments prefer to have a surplus  Ways to achieve a trade surplus o Using FDI as a substitute for imports of goods and services (outsourcing production, basically to avoid account deficits of assets) o When MNE’s use foreign subsidiaries to export goods and services  Effect on Competition and Economic Growth  When FDI acts as a greenfield investment it adds more players in the competitive market → increasing competition in a market and driving down prices which ultimately benefits the consumer. o Host-Country Costs  Adverse Effects on Competition  “If it is part of a larger international organization, a foreign MNE may be able to draw on funds generated elsewhere to subsidize its costs in the host market, which would drive out indigenous companies and allow the firm to monopolize the market.”  When FDI is in the form of acquisition, it may have a neutral effect on competition in the long run  Adverse Effects on the Balance-Of-Payments  There must be enough capital outflow to balance the inflow  A substantial of subsidiary imports from abroad can increase debit on the host countries account  National Sovereignty and Autonomy o Home-Country Benefits  Balance-Of-Payments benefits from inward flow of foreign earnings  Outward FDI arise from employment effects  Home-country MNE attains valuable skills learned from foreign market exposure o Home-Country Costs  Balance-of-payments may suffer in 3 forms  Initial capital outflow  Account suffers if the foreign investment is supposed to serve the home market from a low-cost production location  Account suffers if the FDI is a substitute for direct exports  Employment may be effected if FDI is used as a substitute for domestic production o International Trade Theory and FDI  “International trade theory tells us that home-country concerns about the negative economic effects of offshore production may be misplaced.”  FDI can stimulate economic growth  Gives the home-country more resources  Adds comparative advantage  Dropping prices benefit the consumer Explain the range of policy instruments that governments use to influence FDI.  Government Policy Instruments and FDI o Home-Country Policies  Encouraging Outward FDI  Investor nations have government backed insurance programs to cover foreign investment risk o Expropriation, war losses, and the inability to transfer products back home o Particularly encouraging in politically unstable countries  Special funds or banks for domestic firms who invest in developing countries  Many countries have done away with double taxation on foreign income and have persuaded others to relax restrictions on inbound FDI  Restricting Outward FDI  Limiting capital outflows in concern for the country’s balance-of-payments  Manipulation of tax rules in encourage domestic investment  Prohibiting firms from investing in certain countries for political reasons o Host-Country Policies  Encouraging Inward FDI  Come in the form of: tax concessions, low-interest loans, grants or subsidies from government  Restricting Inward FDI  Ownership Restraints o Exclusion from specific sectors of goods and services  Performance requirements o Controls over the behavior of the MNEs local subsidiary  Most common are related to local content, exports, technology transfer, and local participation in top management  More common in lesser developed countries o International Institutions and the Liberalization of the FDI  The involvement of the WTO gave way to more consistency with the governing of the FDI  The WTO embraced international trade in the form of services simply because you can’t export them Identify the implications for managers of the theory and government policies associated with FDI.  FDI and Government Policy o The Theory of FDI  Why do firms prefer FDI to licensing or exporting?  When Licensing isn’t attractive  The firm has know-how that can’t be protected by a licensing contract  The firm needs tight control over a foreign entity to maximize market value in that country  The firms skills and capabilities aren’t compatible with licensing  When the competitive advantage of a firms is based on managerial or marketing knowledge that’s embedded in the firms routines or managers skills  Industries that tend to avoid licensing  High-tech industries  Global oligopolies  Industries where intense cost pressure requires MNE’s to have tight control o Government Policy  When a host government wants to attract FDI the main issue becomes what benefits it, and the MNE are willing to exchange. When a host government is unsure of what benefits FDI may bring, it’s more likely to put up more restrictions to MNE’s


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