Lecture 5 Flashcards
Global supply chain
Exporters are
Importers.
Importers are
Exporters.
Many
companies
invest and have
operations
across the
world.
Supply chains and economic interests
Not all import-competing sectors benefit from protectionism
* Some firms and workers in import-competing sectors are part of Global
Supply Chains:
These firms also depend on imports as inputs for production
May receive foreign direct investment (more on that later) that depends on trade
openness
Trump’s steel tariff
- In February 2018 Trump imposed a 25% Tariff on Steel Imports from EU and elsewhere
- This should have led to record profits in the US steel industry…
- They should have performed better than traditional stocks.
Did they help the industry? They did for a bit.
However, when Trump imposed tariffs on other
Chinese inputs, things changed. - Chinese imports are key intermediate goods in the
production of many products that also use steel. - This made other parts in goods using steel, but made
in the US, more expensive to make and thus demand
fell - Less steel was demanded because the products
making steel (like cars) became too expensive. - The lesson: The modern supply chain is complex. Simple tariffs can
have complex results.
Maybe our models are too simple for the complex global
economy
2 categories of FDI
Portfolio investment and direct investment
Portfolio investment
Investors have claim on some income, but do not manage the investment (less than a controlling percentage)
Investors only interested in the rate of return
Ex: Stocks, Bonds
Highly mobile, can be sold instantaneously
Includes sovereign lending
Lending directly to a country’s government (We’ll explore this in greater detail in a few weeks)
Direct investment
Investment by a company that owns and controls facilities that are located in another country
Ex. Shell Oil Refinery in Nigeria
Ex. BMW factory in US
Ex. Foxconn factory in Brazil
Highly immobile, requires a fixed-investment
* When we talk about Multinational Companies, we are typically talking about direct investment
MNC, what are they?
Multinational Corporation:
A single corporate structure that controls & manages production establishments in at least 2 countries
* Emerged during the late 19th century
Maybe before (Dutch & British East India Companies)
* Initially UK companies dominated
1
st US MNC in 1867
US overtook UK in 1920s as largest source of FDI
Since 1960s US dominance has diminished
Europe, Japan, and other countries/regions, have gathered steam
* MNCs are not new but the growth of MNCs is.
Why invest abroad?
- Why not just hire a foreign company?
Like Apple does to build its products (Foxconn)
1. Locational Advantages
2. Market Imperfections
Locational advantages
Large reserve of natural resources
Acces a large local market
market-oriented investments
“jump over” trade-barriers!
E.g. car factories in Brazil
Enhance efficiency
lower cost of the factors of production
match the factor intensity of a production stage to the factor abundance of
particular countries:
Go where you get the most for your money
Design the Honda Accord in capital-abundant Japan, Assemble the car in laborabundant Mexico
Market imperfections, horizontal integration
- Intangible asset:
The value is derived from knowledge or from a set of skills/routines possessed by a firm’s
workforce
“know-how” - It is difficult to sell or license intangible assets
Market imperfections, vertical integration
- 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
Time inconsistency in long-term contracts
This is called a time-inconsistent preference 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.
Easier said than done.
* Firms face a similar problem of having different preferences across time
They can eliminate the middle man with vertical integration
* Firms that rely heavily on specific assets are more likely to integrate vertically
MNCs, where and when?
- MNCs are a “predictable” response to the economic environment in which firms
operate - Locational advantages tell us if MNCS are profitable
- Imperfections tell us whether a firm will internalize the production
FDI potential economic benefits
- Transfers savings (capital) between states!!!
Aids economic growth - Technological and managerial experience
Spillover effects: Advanced technology that can be learned from - Integration into global markets
Opportunity to show “worth” to other firms
FDI potential economic costs
- Can potentially reduce domestic capital
Sometimes they borrow domestic capital and “crowd out” investment to other firms
(Over)charge affiliates with licensing fees & royalties for technology, “transfer pricing”
SECOND. Can drive local firms out of business
More competitive (better tech and management) than local firms. - Technology is often tightly controlled, limiting transfers & integration into global
markets - MNC objectives might clash with domestic economic objectives
Can undermine industrial policy or other social policy goals
MNCs in developing world
After independence from colonialism, many states wanted to establish political &
economic autonomy from former powers
Through nationalization or expropriation
* They took control of existing foreign investments and managed the terms of new
investments
* Now, many developing countries are again open to foreign direct investment and
actively try to attract it.
* Why give control back to foreign interests?
* The economic benefits are attractive
Where does FDI go?
- Advanced industrial countries!
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 developing world in
past 30 years.
Still not as big as theory would predict.
Bargaining for FDI
- The state wants the economic benefits
- The MNC wants a profit maximizing environment and limited risk
- State fears: Loss of economic policy control, other negative externalities
- MNCs fear:
Burdensome regulation
Expropriation of investments
Investments are fixed and difficult to remove (i.e. immobile)
The fixed investment can become a hostage.
Democracy and FDI
Some states are better at tying their hands
* Generally, democracies attract more FDI because the costs of expropriation are
greater
* Expropriation buys them little in terms of $$ to provide to a larger group of
supporters
Those $$ buy a lot more support where the individuals needed to remain in power is
smaller
Other types of risk
- Beyond expropriation, firms fear that other policies might eat their profits.
- Policy volatility:
Regulation changes that make conducting business difficult.
Environment, labor laws, tax policy - Transfer risk
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. We’ll look at this in a few lectures. - Violence risk
Civil conflict, terrorism, etc.
Can make doing business more costly or damage fixed assets.
Race to the bottom
- States want to attract FDI and thus offer incentives to firms
- Firms go wherever taxes are lowest, risk is lowest, and regulation is least
burdensome.
Environmental standards, labor practices, kickbacks from governments - Developing states are at a disadvantage b/c of their need for FDI and lack of
economic diversity - Countries that want to attract FDI might lower regulation and taxes
Climb to the top
Firms don’t only want lower taxes and regulation.
* They also want public goods!
Infrastructure, educated workforce (human capital)
These are usually paid for with taxes
* Democracy (remember?) and public good investment may attract FDI
* Also, multinational firms can be subject to pressure to improve “Corporate Social Responsibility”
* FDI then (maybe) pressures governments to grow and incentivizes “better” political regimes and
public good investments.
International regulation of MNCs
- No Multilateral Rules or Institutions like those that govern trade.
- Some “legal” norms of behavior but no enforcement mechanism
- Attempts thus far have been unsuccessful, countries’ interests clash:
Advanced industrialized countries want protections for investors
Developing countries want rights for host countries
Bilateral investment traties (BITs)
In the absence of global rules, states have turned to bilateral treaties to govern int’l
investment
* 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)
