Week 4

Question 1

In the neo-classical explanations of FDI, what are the key assumptions made? What does this mean?

Answer 1

Capital and labour are assumed to be immobile between countries.

This cannot explain flows of capital or labour

Question 2

Which neoclassical models attempt to explain FDI and labour migration?

Answer 2

The differential rate of return theory
Mundells HO model

Question 3

Explain the differential rate of return theory

Answer 3

Countries have asymmetric factor endowments. To efficiently use these scare factors of production, they are shifted and sent to where they have the highest marginal product.

Question 4

What diagram is used to depict the differential rate of return?

Answer 4

The MacDougall Diagram

Question 5

What are the conclusions from the MacDougall diagram?

Answer 5

Leads to factor prices being equalised
Leads to higher output and improved efficiency

Question 6

What are some critiques of the differential rate of return theory?

Answer 6

Assumes perfect information and perfect competition
Assumes rate of return on all capital is the same
CANNOT EXPLAIN CROSS-FLOWS OF FDI

Question 7

What other massive empirical flaw does the differential rate of return theory have?

Answer 7

Global data on FDI flows does not support it.

Question 8

Talk about cross flows of FDI in relation to the differential rate of return theory.

Answer 8

The greatest proportion of FDI flows is between industrialised countries. Because capital is assumed to be homogenous, we cannot appreciate why FDI might go in both directions.

Question 9

Describe Mundell’s HO model.

Answer 9

Neo-classical Heckscher-Ohlin model.
Says that FDI and labour migration respond to the presence of trade barriers. The more restrictions on factor mobility, the more trade. They are substitutes

Question 10

What are some critiques of Mundell’s model?

Answer 10

Again, it cannot explain cross-flows of FDI.
Assumes substitution so there could be no FDI if we have free trade.

Question 11

How did Stephen Hunter move from these disappointing results to explain FDI?

Answer 11

Approaches that assume competitive markets and homogenous capital can’t explain the real world. He looked at MNEs on a firm level.

Question 12

What were the reasons Hymer identified for the increasing involvement of MNEs in the world economy

Answer 12

-New and large profit opportunities. Could also reduce market concentration
-Can exploit competitive advantage internationally at low cost
-Diversification of portfolio benefits. Rescues one country’s political, financial and economic risk.

Question 13

What other two big factors should an MNE consider before operating in more countries?

Answer 13

The liability of foreignness
Transaction costs

Question 14

What is the liability of foreignness?

Answer 14

Idea that MNEs must have sufficient competitive advantages to more than offset the disadvantage of not having local knowledge, expertise and connections.

Question 15

What are transaction costs?

Answer 15

Factors impeding business due to market imperfections. Like geographical distance or limited knowledge

Question 16

How do MNEs deal with transaction costs?

Answer 16

They minimise transaction costs through improving efficiency and coordination.

Question 17

Do MNEs improve global welfare. Give an argument for and against.

Answer 17

Yes - higher R&D, more innovation, lower costs and higher quality

No - reduce global competition and earn substantial profits

Question 18

What is appropriability?

Answer 18

A firms capability to capture potential rents from their competitive advantages..

Question 19

What is a tangible asset?

Answer 19

Assets that have clearly defined property rights and can be protected by law - IPRs

Question 20

How could a firm maximise the appropriability of tangible assets?

Answer 20

Given they are easily defined and therefore protected, the firm can:
-exploit them internally
-license (rent) them
-sell

Question 21

What is an intangible asset?

Answer 21

Assets that don’t have clearly defined property rights and so cannot be easily protected by law.

Question 22

How do firms maximise the appropriability of rents on intangible assets?

Answer 22

Internalisation. If leaked, there are substantial negative externalities for a firm

Question 23

What are 5 factors that determine the competitive advantage of particular locations/countries?

Answer 23

• Market characteristics
• psychic/cultural distance
  -price and quality of inputs
  -host govt policies
  -institutional voids

Question 24

What are institutional voids?

Answer 24

The inefficiency/absence of institutions in host countries. This could attract and put off firms

Question 25

What is the international division of labour in relation to Adam smith?

Answer 25

It extends adam smiths division of labour to the international level

Question 26

What is the international division of labour?

Answer 26

The idea that the spatial location of economic activity depend on differences in real wages (money wage/productivity)

Question 27

Can standard neo classical models explain IB?

Answer 27

Absolutely not. They are useless.

Question 28

What type of model is the differential rate of return model? Does trade occur?

Answer 28

An investment model. No trade occurs. Capital is just moved to where returns are highest.

Question 29

Under the differential rate of return theory, what would we expect to see in imperfect capital markets?

Answer 29

Arbitrage. Agents borrow from where capital is cheap and they invest it where reruns are high.

Question 30

What do both DRR and Mudells H-O models assume that isn’t strictly true.

Answer 30

That FDI ONLY a flows from relatively capital rich counties to capital scarce countries. This cannot explain 75% of total FDI cross-flows.

Question 31

What assumptions have to be relaxed to provide a more empirically sound understanding of global patterns of FDI?

Answer 31

CAPITAL ISNT HOMOGENOUS MARKETS ARENT PERFECT. There’s little we can understand from overly aggregated macro models. Hymer introduced looking at FDI through the lens of the firm.