Supply Chains, FDI and MNCs Flashcards
1
Q
Supply chains and economic interests
A
- 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 that depends on trade openness - eg. Milner and Jamal’s 2019 Survey in Tunisia founds 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
2
Q
Trump’s Steel Tariff
A
- In February 2018 Trump imposed a 25% tariff on steel imports from EU and elsewhere (import-competing sector)
- 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
3
Q
What does Trumps steel tariff teach us?
A
- The modern supply chain is complex, simple tariffs can have complex results
- Maybe our models are too simple for the complex global economy
4
Q
Two categories of foreign investment
A
- Portfolio investment
- Direct investment
5
Q
Portfolio investment (categories of foreign investment)
A
- 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
- eg. Stocks, Bonds
– Highly mobile, can be sold instantaneously - Includes sovereign lending
– Lending directly to a country’s government
6
Q
Direct investment (categories of foreign investment)
A
- Investment by a company that owns and controls facilities that are located in another country
– eg. Shell Oil refinery in Nigeria
– eg. BMW factory in US
– eg. Foxconn factory in Brazil - Highly immobile, requires a fixed-investment
7
Q
What is an MNC?
A
- Multinational Corporation:
– A single corporate structure that controls and manages production establishments in at least 2 countries - Emerged during the late 19th century
– Maybe before (Dutch and British East India Companies) - Initially UK companies dominated
– 1st 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
8
Q
Why invest abroad?
A
- Why not just hire a foreign company?
– Like Apple does to build its products (Foxconn) - Locational advantages
- Market imperfections
9
Q
Locational advantages (reasons to invest abroad)
A
- Large reserve of natural resources
- Access a large local market
– Market-oriented investments
– “Jump over” trade barriers - 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 labor-abundant Mexico
10
Q
Market imperfections, horizontal integration (reasons to invest abroad)
A
- Intangible asset:
– eg. How much is the Coca-Cola formula worth?
—> 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
- Paradox of information
– The value of the information for the purchaser is not known until she has the information but then she has acquired it without cost - The owner of the information is unwilling to share info, the purchaser is unwilling to buy
- Rather than sell the information, the firm can simply set up shop in a new location
11
Q
Market imperfections, vertical integration (reasons to invest abroad)
A
- 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
12
Q
Time inconsistency in long-term contracts
A
- What you want today is not what you’ll want tomorrows (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 vartically
13
Q
Where and when MNCs?
A
- 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
14
Q
FDI’s potential economic benefits
A
- 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
15
Q
FDI’s potential economic costs
A
- Can potentially reduce domestic capital
– Sometimes they borrow domestic capital and “crowd out” investment to other firms
– (Over)charge affiliates with licensing fees and royalties for technology, “transfer pricing”
– Require affiliates to purchase inputs abroad from MNC - Can drive local firms out of business
– More competitive (better tech and management) than local firms
– Like the Walmart effects - Technology is often tightly controlled, limiting transfers and integration into global markets
- MNC objectives might clash with domestic economic objectives
– Can undermine policy or other social policy goals
16
Q
MNCs in the developing world history and development
A
- After independence from colonialism, many states wanted to establish political and 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?
17
Q
MNCs in the developing world effects
A
- The economic benefits are attractive
- States try to manage FDI and MNCs to their advantage
– Prohibited ownership of: utilities, extractive industries and other important industries
– Required some local ownership
– Imposed performance requirements - Countries varied in how they regulated FDI
– Thus, competition to attract FDI was born
18
Q
Where does FDI go?
A
- 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
19
Q
Bargaining for FDI
A
- 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 (ie. immobile)
—> The fixed investment can become a hostage - Obsolescing bargain:
– Over time, bargaining power shifts towards the governments (because fixed investments grow) - These fears (the time inconsistency problem) make attracting FDI difficult for states
20
Q
Democracy and FDI
A
- 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 money to provide to a larger group of supporters
– That money buys a lot more support where the individuals needed to remain in power is smaller - Plus, FDI has widespread benefits
– Leaders will be punished (with poor economic growth) if they deter investment with expropriation - Democracies have more “veto players” that can constrain policy choices
21
Q
Other risks of FDI
A
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
- Violence risk
– Civil conflict, terrorism, etc.
– Can make doing business more costly or damage fixed assets
22
Q
The “Race to the Bottom” (FDI)
A
- 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 because of their need for FDI and lack of economic diversity
- Countries that want to attract FDI might lower regulations and taxes
23
Q
The “Climb to the Top” (FDI)
A
- Firms don’t only want lower taxes and regulation they also want public goods
– Infrastructure, educated workforce
– These are usually paid for with taxes - Democracy and public goo 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 goods investment
24
Q
International regulation of MNCs
A
- 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
25
Bilateral Investment Treaties (BITs)
- In the absence of global rules, states have turned to bilateral treaties to govern international investment
- BITs govern:
-- Treatment of foreign investors under the law
-- Protection of assets and flows of assets
-- Basically, they make sure foreign firms aren't exploited by host government
- BITs tend to be highly skewed towards the rights of foreign investors (as opposed to host countries)
26
Investor-State Dispute Settlement (ISDS)
- Provision included in many trade agreements (such as TPP) and BITS
- Allows investors to sue countries for "expropriation" and rulings may take precedence over country's laws
-- Traditionally expropriation meant the literal seizing of assets
-- But now often much broader, eg. expropriation of expected profits through new regulations
- Suit is head in private court adjudicated by a panel of arbitrators
- Cost of lawsuits might be crippling for poor countries
- Many suggest the system is being abused and infringes on norms of sovereignty, countries have started pulling out/not renewing BITs over it
