3.1 supply chains, FDI and MNCs

Question 1

not all import-competing sectors benefit from protectionism
bc?

Answer 1

some firms and workers in import-competing sectors are part of Global Supply Chains:

• they also depend on imports as inputs for production
• may receive FDI that depends on trade openness

E.g. Milner and Jamal’s 2019 survey in Tunisia finds that workers in import-competing sectors that are embedded in Global Supply Chains are more supportive of free trade than those not embedded in Global Supply Chains

Question 2

Trump’s Steel Tariff

Answer 2

feb 2018 Trump imposed a 25% tariff on steel imports

should have led to record profits in the US steel industry, should have performed better than traditional stocks

did the tariff help the industry? for a bit, but Trump imposed tariffs on other Chinese inputs

Chinese inputs = key intermediate goods in the production of many products that also use steel

less steel was demanded bc the products making steel (like cars) became too expensive

the lesson =

1. the modern supply chain is complex, simple tariffs can have complex results
2. maybe our models are too simple for the complex global economy

Question 3

2 categories of foreign investment

Answer 3

portfolio investment

• investors have claim on some income, but don’t manage the investment (less than a controlling percentage)
• investors only interested in the rate of return
• e.g. stocks, bonds
• highly mobile, can be sold instantaneously
• includes sovereign lending: lending to a country’s gov

direct investment

• investment by a company that owns and controls facilities that are located in another country (needs to own controlling percentage, to be in charge of a company)
• e.g. Shell Oil Refinery in Nigeria, BMW factory in US, Foxconn factory in Brazil
• highly immobile, requires a fixed-investment (investor becomes deeply invested in the supply chain)

!when we talk about MNCs, we typically talk about direct investment

Question 4

what is a multinational corporation?

Answer 4

MNC = single corporate structure that controls and manages production establishments in at least 2 countries

• emerged late C19, maybe before (Dutch and British East India Companies)
• initially UK companies dominated
• US overtook the UK in 1920 as largest source of FDI
• since 1960s US dominance has diminished

MNCs are not new, but the growth of MNCs is

FDI increase over time, shocks in ….. (ask notes someone else)

Question 5

2 types of FDI

Answer 5

horizontal = same level of production in multiple countries

• e.g. Heineken brews beer across the world

vertical = different parts of the value chain produced in different locations

• e.g. Starbucks owns its own coffee farm in Costa Rica
• company takes over entire supply chain by producing all elements of a final product, in diff locations

Question 6

why invest abroad?

Answer 6

Locational advantages = is it profitable? = go where you get the most for your money

Market imperfections = horizontal integration = why not just hire a foreign company?

• horizontal integration: intangible assets
• vertical integration: specific assets

Question 7

why invest abroad
- locational advantages

Answer 7

large reserve of natural resources (vertical FDI)

enhance efficiency (vertical FDI): lower cost of the factors of production, match the factor intensity of a production stage to the factor abundance of particular countries

• e.g. design the Honda Accord in capital-abundant Japan, Assemble it in labor-abundant Mexico

access a large local market (horizontal FDI) =

• market-oriented investments
• “jump over” trade-barriers (e.g. car factories in Brazil: large market, make it into a local product to sell much without the barriers)
  = more protectionism -> more incentive for horizontal FDI

Question 8

why invest abroad?
- market imperfections, horizontal integration

Answer 8

horizontal integration

intangible assets = “know-how” = difficult to sell or license

• value is derived from knowledge or from a set of skills/routines possessed by a firm’s workforce
• e.g. Coca-Cola formula, inner workings of iOS, details of management at a firm like VW

paradox of information:
the value of information for the purchaser is not known until she has the information, but then she has acquired it without cost

• owner of the information is unwilling to share info, the purchaser unwilling to buy
• one I know, why would I pay for explanation? And why would I do it for them if I know how to make the whole thing?
• the info a company has to sell is the product it wants to sell = sensible

rather than sell information, the firm can simply set up shop in a new location

Question 9

why invest abroad?
- market imperfections, vertical integration

Answer 9

specific assets - dedicated to a particular long-term economic relationship

• difficult to enforce long-term contracts
• one party in the long-term relationship can take advantage of the specific nature of the asset to extract a larger share of the value from the transaction
  one party has leverage to make concessions of the other in the future and engage in opportunistic behavior

vertical integration eliminates this problem arising from specific assets

e.g. Oil Producers and Pipelines

-Time 1 : pipeline company promises to build pipeline if oil company signs
If nothing happens, both have 0 as no profit and no loss (same for if promise not held, ex if no signing?)
- But once pipeline built, oil company is dependent on pipeline you just built = oil company could honor deal and get a payoff of 6 and constructer gets a payoff of 5
- But as control of pipeline that oil company really needs and has not invested anywhere else = renegotiate to squeeze more money out of company bu holding hostage to make it pay more than owed
= oil company may accept to pay more to not lose pipeline, and might even end worse off than if they never signed pipeline deal

= issue of specific assets

Question 10

time inconsistency in long-term contracts

Answer 10

time inconsistency problem = what you want today is not what you’ll want tomorrow (and others know it!)

you need to find a way to lock in your current preferences to solve the problem

in production: firms can eliminate this problem by cutting out the middle-man: vertical integration = oil company buys the pipeline company

firms that rely heavily on specific assets are more likely to integrate vertically

Question 11

where and when do we get MNCs?

Answer 11

MNCs are predictable response to eco environment:

locational advantages tell us if MNCs are profitable

imperfections tell us whether a firm will internalize the production

Oatley table 8.4

• locational advantages + intangible assets = horizontal integrated MNC, market based
• locational advantages + specific assets = vertical integrated MNC, natural resource based, cost based
• no locational advantages + intangible assets = horizontal integrated domestic firm
• no locational advantages + specific assets = vertically integrated domestic firm

aka

intangible assets -> horizontal integration, market based
specific assets -> vertical integration, natural resource based, cost based
locational advantage -> MNC
no locational advantage -> domestic firm

*market based = investment in a market to gain access to it (e.g. horizontal FDI to produce cars in Brazil)

Question 12

why attract FDI?
potential eco benefits =

Answer 12

1. transfers savings (capital) between states!!!
   aids eco growth
2. technological and managerial experience
   spillover effects: advanced tech that can be learned from
3. integration into global markets
   opportunity to show “worth” to other firms

Question 13

FDI’s potential economic costs

Answer 13

1. can potentially reduce domestic capital
   - sometimes they borrow domestic capital and crowd out investment to other firms
   - (over)charge affiliates with licensing and royalties for technology, “transfer pricing”
   - require affiliates to purchase inputs abroad from MNC
2. can drive local firms out of business (MNC more competitive than local firms bc better tech and management)
3. technology is often tightly controlled, limiting transfers and integration into global markets
4. MNC objectives might clash with domestic economic objectives
   - can undermine industrial policy or other social policy goals

Question 14

MNCs in the developing world

Answer 14

independence -> want for political and economic autonomy -> nationalization and expropriation

-> took control of existing FDI and managed the terms of new investments

now = many developing countries again open to FDI and actively try to attract it bc:

• economic benefits are attractive
• states try to manage FDI and MNCs to their advantage: prohibited ownership of utilities and important industries, required some local ownership, imposed performance requirements
• countries varied in how they regulated FDI -> competition to attract FDI

Question 15

how does FDI flow between developed and developing countries?

Answer 15

expectation = FDI flows should flow from developed to developing countries

• bc developed states have an abundance of capital, developing countries have a scarcity

but the data says otherwise:

• advanced industrial countries are both the largest providers and recipients of FDI
• FDI to developing world is concentrated : largely in most populous and wealthy countries (BRICS)
• FDI has increased to the developing world in the past 30y (still not as big as theory would predict)

Question 16

bargaining for FDI - states and MNCs

Answer 16

state wants the eco benefits, MNC wants a profit maximizing environment and limited risk

state fears = loss of eco policy control, other negative externalities

MNCs fear =

• burdensome regulation
• expropriation of investments: they are fixed and difficult to remove (immobile) -> can become hostage

obsolescing bargain = over time, bargaining power shifts towards the government (bc fixed investments grow)

fears -> attracting FDI difficult for states -> how can govs tie their hands?
(maybe some notes?)

Question 17

democracy and FDI

Answer 17

some states are better at tying their hands

generally, democracies attract more FDI bc costs of expropriation are greater
- expropriation = gov claiming privately owned property against the wishes of the owners, to be used for the benefit of the overall public

• expropriation buys them little in terms of $$$ to provide a larger group of supporters
  $$$ buy a lot more support where the individuals needed to remain in power is smaller
• FDI has widespread benefits: leaders will be punished (with poor eco growth) if they deter investment with expropriation

democracies have more “veto players” that can constraint policy choices

-> democracy gives firms more certainty that they can keep the gains of their investments

Question 18

FDI risks for firms
5

Answer 18

fear that policies might eat their profits

• expropriation
• policy volatility:
  regulation changes that make conducting business difficult
• transfer risks:
  restriction on ability to convert currency to move profits out of the country
• exchange rate risk:
  unstable exchange rates (led by monetary policy) can also eat into profits
• violence risk:
  civil conflict, terrorism etc., can make doing business more costly or damage fixed assets

Question 19

attracting FDI through a “Race to the Bottom”?

Answer 19

states want to attract FDI -> offer incentives to firms

firms go where:

• low taxes
• low risk
• least burdensome regulation (environmental standards, labor practices, kickbacks from gov)
  kickbacks from gov = punishment + control

developing states are at a disadvantage bc of their need for FDI and lack of economic diversity

-> countries that want to attract FDI might lower regulation and taxes

evidence = no clear evidence of a race to the bottom on regulation
*race to the bottom = standards decreasing because of competition

• states that attract mroe FDI do not perform worse on labor rights, democracy, or environmental protection
• FDI is positively correlated with labor rights and negatively associated with child labor

!in some specific industries there is some evidence of a race to the bottom (textiles, extractive industries, and a few others)
*getting an answer is tough: have to disentangle FDI/trade (MNCs may hire local contractors to do their dirty work)

Question 20

“climb to the top”

Answer 20

FDI may pressure gov to grow and incentivizes “better” political regimes and public good investments :
= way to attract FDIs is not to lower taxes and regulations, but rather have better system and infra and be able to tie your hands better against expropriation

bc firms don’t just want lower taxes and regulations, also want public goods (infrastructure, educated workforce (human capital))

• infrastructure necessary for efficient production

+ bc MNCs can be subjective to pressure to improve “Corporate Social Responsibility”

Question 21

“race to the bottom” in taxes through transfer pricing

Answer 21

companies can shift their profits into low-tax jurisdictions through “transfer pricing” without shifting production

• for taxes, race to the bottom logic is the most credible

transfer pricing = trade within MNCs (60% of all international trade) = all completely legal

e.g. double Irish Dutch sandwich = 3 companies (irish, irish company in a tax haven + dutch shell company (only used to move money around)

• selling bananas in australia, buy them from irish company, make hardly any profit -> virtually no tax in Australia, but now money is in Ireland, is send to the Dutch company as management fees (tax free bc within EU), Dutch company has to pay almost everything to the Irish company in tax haven bc brand licensing fees -> no corporate tax

Question 22

international regulation of MNCs

Answer 22

no multilateral rules or institutions like those governing trade

some “legal” norms of behavior but no enforcement mechanism

attempts thus far have been unsuccesful, countries’ interests clash:

• advanced industrial countries want protections for investors
• developing countries want rights for host countries

Question 23

bilateral investment treaties

Answer 23

= BITs
govern:

• treatment of foreign investors under the law
• protection of assets and flow of assets
• basically, they make sure foreign firms aren’t exploited by host governments

BITs tend to be highly skewed towards the rights of foreign investors (as opposed to host countries)

the NL has BITs with over 100 countries, almost all developing states

Question 24

investor-state dispute settlement

Answer 24

= ISDS

provision included in many trade agreements (such as TPP) and BITs

allows investors to sue countries for “expropriation” and ruling may take precedence over country’s laws

• traditionally expropriation = literal seizing off assets
• now = broader: expropriation of expected profits through new regulations

suit is heard in private court adjudicated by a panel of arbitrators

costs of lawsuit might be crippling for poor countries

may suggest the system is being abused and infringes on norms of sovereignty, countries have started pulling out/not renewing BITs over it

• e.g. India, Indonesia, Ecuador, South Africa

Question 25

progress on taxes: the OECD minimum tax

Answer 25

(Taxes most likely race to the bottom)

subjects MNCs a minimum tax: 15% for OECD countries + other countries that have signed up

winners: biggest tax losers (e.g. US, Germany, Brazil, France, India)

losers: biggest contributors to tax losses (enable corporate tax abuse)
- NL, Cayman Islands, China, Hong Kong

• others will implement it whether or not they will also employ the minimum tax, so might as well implement it in their own country

corporate profit tax

add stuff from someone’s notes

Question 26

take aways:

Answer 26

• supply chains complicate the story about winners and losers of trade
• there are a number of economic reasons why companies invest abroad
• there are political obstacles to MNC investment (states and MNCs have different incentives + time inconsistency problems and credible commitments)
• democracy and good institutions can help attract FDI
• evidence for “race to the bottom” or the “climb to the top” mixed across types of governance and sectors
• no coherent international regime regulating FDI, but progress on international tax regime

Question 27

global supply chain

Answer 27

inputs of production of a product that come from all around the world to be assembled in 1 place

Exporters are importers of what they need, and exporters of what they produce

Question 28

FDI and the commitment problem

Answer 28

specific assets:

if a company relies on specific assets for a part of production, the company providing that asset can weaponize it in a sense: the other company becomes dependent on it, so the delivering company can renegotiate: make the asset more expensive

obsolescing bargain: bargaining power shifts to governments rather than MNC bc expropriation

• gov. may be better of by expropriating than staying stuck in an agreement, can cut of investment

Question 29

reading -

Answer 29

By extending managerial control across borders, MNCs enable decisions from a home country to impact resources in foreign countries, often creating tensions in host nations