International Factor Movements

• International Factor Movements
  and Multinational Enterprises

• Chapter Outline
• The Multinational Enterprise
• Motives for Foreign Direct Investment Supplying Products to Foreign Buyers: more
• Country Risk Analysis
• International Trade Theory and Multinationals
• Japanese Transplants in the U.S. Automobile Industry (new)
• International Joint Ventures
• Multinational Enterprises as a Source of Conflict
• International Labor Mobility: Migration
• The Multinational
  Enterprise (1 of 4)
• The Multinational Enterprise (MNE)
• Operate in many host countries
• Often conduct research and development (R&D) activities, in addition to manufacturing, mining, extraction, and business-service operations
• Often directed from a company planning center distant from host country
• The Multinational Enterprise (2 of 4)
• The Multinational Enterprise (cont.)
• Multinational stock ownership
• Multinational company management
• High ratio of foreign sales to total sales
• Types of integration:
• Vertical integration:
• Parent MNE establishes foreign subsidiaries to produce intermediate goods or inputs that go into the production of a finished good
• 9.1
• The Multinational Enterprise (3 of 4)
• Types of Integration (cont.)
• Horizontal integration
• Parent company produces commodity in source country
• Sets up subsidiary to produce identical product in host country
• Conglomerate integration
• Diversify into nonrelated markets
• The Multinational Enterprise (4 of 4)
• Foreign direct investment by parent co.
• Obtains sufficient common stock in a foreign company to assume voting control
• Constructs new plants and acquires equipment overseas
• Shifts funds abroad to finance expansion of its foreign subsidiaries
• Earnings of foreign subsidiaries reinvested in plant expansion
• 9.2
• Motives for Foreign
  Direct Investment (1 of 3)
• Foreign Direct Investment (FDI)
• Motivated by higher rates of return on investment
• Leads to economic growth and job creation
• Generates spillovers
• Improved management and better technology
• Higher average labor productivity
• Higher wages
• Stimulates exports of capital goods
• Motives for
  Foreign Direct Investment (2 of 3)
• Demand Factors
• New markets and sources of demand
• Tap foreign markets that cannot be maintained adequately by export products (licensing rights)
• Parent company – productive capacity already sufficient to meet domestic demand
• Market competition
• Direct exporting
• Motives for
  Foreign Direct Investment (3 of 3)
• Cost Factors
• Reductions in production costs
• Acquisition of essential raw materials
• Lower labor costs
• Decreased transportation costs
• Government policies
• Economies of scale
• Direct exporting – foreign demand small
• Licensing agreement/FDI – demand is large
• Supplying Products to Foreign
  Buyers: Whether to Produce
  Domestically… (1 of 2)
• Direct Exporting versus Foreign Direct Investment/Licensing
• Economies of Scale (See Fig 9.1)
• Small Demand/Output – Direct Exports
• Large Demand/Output – FDI/Licensing
• Low Transportation Cost – Direct Exports
• High Transportation Cost – FDI/Licensing
• Low Trade Restrictions – Direct Exports
• High Trade Restrictions – FDI/Licensing
• 9.1
• Supplying Products to Foreign Buyers: Whether to Produce Domestically… (2 of 2)
• Foreign Direct Investment versus Licensing
• Decision to establish foreign operations through Direct Investment or Licensing depends on (see Fig. 9.2)
• Capital used in production
• Size of foreign market
• Fixed cost of establishing overseas facility
• 9.2
• Country Risk
  Analysis (1 of 3)
• Country Risk Analysis
• Political risk analysis
• Assesses political stability of country

–Government stability, corruption, domestic conflict, religious tensions, and ethnic tensions

• Financial risk analysis
• Investigates country’s ability to finance its debt obligations

–Foreign debt as percentage of GDP, loan default, and exchange rate stability

• Country Risk Analysis (2 of 3)
• Country Risk Analysis (cont.)
• Economic risk analysis
• Determines country’s current economic strengths and weaknesses
• Rate of growth of GDP, per capita GDP, inflation rate
• Composite country risk rating
• Overall assessment of risk of doing business in country
• Country Risk Analysis (3 of 3)
• Country Risk Analysis (cont.)
• International Country Risk Guide
• Political risk factors – weighting of 50%
• Financial and economic risk factors – 25% each
• Low risk: 80–100 points
• Moderate risk: 50–79 points
• High risk: 0–49 points
• 9.3
• International Trade Theory
  and Multinational Enterprise
  (1 of 2)
• Conventional trade model
• Movement of merchandise among nations
• Goods are exchanged between independent organizations
• On international markets
• At competitively determined prices
• International Trade Theory
  and Multinational Enterprise (2 of 2)
• Multinational-enterprise analysis
• International movement of factor inputs
• Aggregate welfare of both source and host countries is enhanced
• Vertically diversified companies
• Subsidiaries manufacture intermediate and finished goods
• Sales can be intrafirm

–Value may be determined by factors other than competitive pricing system

• Foreign Auto Assembly Plants
  in the United States (1 of 2)
• Transplants – direct investment in U.S.-based assembly facilities
• Benefits to Japan include
• Silencing critics who say autos must be built in U.S.
• Avoiding import barriers of U.S.
• Gaining access to expanding markets
• Providing hedge against changes in exchange rates between U.S. dollar and Japanese yen
• 9.4
• Foreign Auto Assembly Plants in the United States (2 of 2)
• Expectations of Japanese Transplants in U.S.
• Would generate jobs
• Expand consumer choice
• Create demand for auto parts industry in U.S.
• Transfer technology from Japan to U.S.
• What actually happened
• Created fewer jobs than expected
• Imported parts from Japan rather than buying locally
• Contributed to U.S. automotive trade deficit
• International Joint
  Ventures (1 of 5)
• International joint ventures
• Business organization established by two or more companies
• Combine their skills and assets
• Limited objective (research or production)
• Short-lived
• Multinational in character
• Several domestic and foreign companies
• Creation of new business firm
• International Joint Ventures (2 of 5)
• International joint ventures (cont.)
• Types of International Joint Ventures
• Joint venture by two businesses that conduct business in third country
• Joint venture with local private interests
• Joint venture with participation by local government
• International Joint Ventures (3 of 5)
• International joint ventures (cont.)
• Justifications for joint ventures
• Some functions too costly for one company to absorb by itself
• Some governments place restrictions on foreign ownership of local businesses
• To prevent excessive political influence
• To minimize dividend transfers abroad
• Forestalling protectionism against imports
• International Joint Ventures (4 of 5)
• Welfare Effects
• Advantages of joint ventures
• Productivity and welfare gains

–Increased productive capacity and additional competition

–Entrance into new markets that neither parent could have entered individually

–Cost reductions that would have been unavailable if each parent performed same function separately

–Increased market power; greater ability to influence prices

• International Joint Ventures (5 of 5)
• Welfare Effects (cont.)
• Disadvantages of joint ventures
• Cumbersome organization
• Divided control

–Different objectives, corporate cultures, and ways of doing things

• Deadlocks in decision making
• Negotiations involve hierarchical command
• Can lead to welfare losses (market-power effect)
• 9.3
• Multinational Enterprises
  as a Source of Conflict (1 of 6)
• Employment
• Effects on employment
• Recipient country

–Employment increases

• Source country

–Employment declines in short term

–Other industries – foreign sales rise over time

• Multinational Enterprises
  as a Source of Conflict (2 of 6)
• Technology Transfer
• Technology transfer facilitated through demonstration effect and competition effect
• Increases productivity and competitiveness of recipient nations
• Donor nations may view it negatively because may decrease export potential and cause job loss
• General Electric: trade-off for entry into the Chinese market
• Short-term sales for long-term competition
• Multinational Enterprises
  as a Source of Conflict (3 of 6)
• National Sovereignty
• Many nations fear presence of MNEs results in loss of national sovereignty
• MNEs may affect economic and other policies of host and source governments
• May be able to shift profits overseas and evade taxes of host country
• Political influence of MNEs problematic

–Example: Chile and MNEs’ influence on election of president

• Foreign subsidiary of MNE may trade with nation against which home country has embargo
• Multinational Enterprises
  as a Source of Conflict (4 of 6)
• Balance of payments
• Positive contribution
• MNE typically purchases capital and other equipment from home country
• Inflow of income generated by overseas operations

–Earnings of overseas affiliates, interest and dividends, and fees and royalties

• Negative contribution
• Short-term outflow of capital
• Multinational Enterprises
  as a Source of Conflict (6 of 6)
• Transfer Pricing
• Pricing of goods within MNE
• May be arbitrary and unrelated to costs incurred or to operations carried out
• Choice of transfer prices affects division of total profit among parts of company and thus influences overall tax burden
• International Labor
  Mobility: Migration (1 of 10)
• United States
• Favorite target for international migration
• Described as melting pot of the world
• Western Europe the major source of immigrants for U.S. – 1820 – 2012
• Germany, Italy, and the United Kingdom
• In recent years, large number of Mexican and Asian immigrants
• Migrants – motivated by
• Better economic opportunities
• Noneconomic factors: politics, war, and religion
• 9.5
• International Labor Mobility:
  Migration (2 of 10)
• The Effects of Migration
• Mexican immigration to U.S.
• Workers migrate from uses of lower productivity to higher productivity

–World output expands

• U.S. as whole benefits from immigration

–Income gain is sum of losses of native U.S. workers, gains by Mexican immigrants, and gains by U.S. capital owners

• Mexican labor supply decreases, increasing wages
• U.S. labor supply increases, decreasing wages
• International Labor Mobility:
  Migration (3 of 10)
• The Effects of Migration (cont.)
• Mexican workers immigrate to the U.S. (cont.)
• Effect of Labor Mobility is to equalize wages
• Redistribute income from labor to capital in the United States
• Redistribute income from capital to labor in Mexico
• 9.4
• International Labor Mobility:
  Migration (4 of 10)
• Immigration as an Issue
• Domestic labor groups prefer restrictions on immigration
• Domestic manufacturers favor unrestricted immigration as source of cheap labor
• Drain on government resources
• Long-term calculations: immigrants make a net positive contribution to public coffers
• International Labor Mobility:
  Migration (5 of 10)
• Immigration as an Issue (cont.)
• Developing nations fear brain drain
• Emigration of highly educated and skilled people from developing nations to industrial nations
• Limiting the growth potential of developing nations
• Guest workers
• Temporary migration, as workers are needed
• Illegal migration
• International Labor Mobility:
  Migration (6 of 10)
• Immigration as an Issue (cont.)
• Immigrants make net positive contribution
• Diversify economy
• Contribute to economic growth
• Lower prices for consumers
• Domestically produce a wider variety of goods
• Increase supply of labor in economy

–Similar skills – lower wage

–Complementing skills – higher wage

• Human capital formation costs – native country
• Contribution to social security
• International Labor Mobility:
  Migration (7 of 10)
• Does Canada’s Immigration Policy Provide a Model for the U.S.?
• Goal of Canadian immigration system to encourage youthful, bilingual, high-skill immigration in order to build human capital within Canada’s aging labor force
• Canada treats foreign workers not as foes but friends whose labor & skills are essential
• Canada currently solicits immigrants from more than 200 countries of origin, especially China, India and the Philippines
• International Labor Mobility:
  Migration (8 of 10)
• Does Canada’s Immigration Policy Provide a Model for the U.S.? (cont.)
• Canada needs immigrants for economic development
• Immigration program run by provincial & federal governments
• A province can select whomever it wants; federal government’s role limited to security, criminal, and health check of foreigners
• Canada – 2/3 of permanent visas granted to fill economic needs
• In U.S., by contrast, 2/3 granted for family reunions
• International Labor Mobility:
  Migration (9 of 10)
• Does Canada’s Immigration Policy Provide a Model for the U.S.? (cont.)
• Multiculturalism is key ingredient of Canadian national identity
• Canadians see immigration as adding to social fabric of country
• Canada has become immigrant country

–Foreign born population of 20%

–U.S. foreign born population is 13%

• Immigration program revised to place more emphasis on job skills and fluency in French or English
• International Labor Mobility:
  Migration (10 of 10)
• Does Canada’s Immigration Policy Provide a Model for the U.S.? (cont.)
• In 2013, Canada began overhaul of immigration program, to address increasing economic division between locals and immigrants
• New system considers

–Whether immigrants have employment arranged in Canada

–Whether they have skills in demand; and

–Immigrants’ adaptability, e.g., time spent previously in Canada, fluency in English or French

• Remains to be seen how revised system will play out