1. Economics for Managers by Dr. William Hua WANG Associate Professor, China Area Manager Euromed Management Ecole de Marseille William-hua.wang@euromed-management.com Office: 321a.

2. V. The Global Economy

3. Summary V The Global Economy 5.1 International trade and comparative advantage 5.2 MNCs and foreign direct investment – foreign firms in China vs. Chinese overseas investment

4. 1.Why Trade? 2.International versus Intranational Trade 3.The Law of Comparative Advantage 4.Dynamic Comparative Advantage 5.Trade Restrictions 5.1 International Trade and Comparative Advantage

5. Why Trade? Reasons countries benefit from foreign trade –They can import resources they lack at home. –They can import goods for which they are a relatively inefficient producer. –Specialization sometimes permits economies of large-scale production. Mutual Gains from Trade –When trade is voluntary: Both sides must expect to gain from it Otherwise, they would not trade 1

6. Why international trade is studied separately: –Countries are governed by separate governments –International trade involves the exchange of national currencies –Labor and capital are less mobile internationally than they typically are within a country International vs. Intranational Trade 2

8. Absolute advantage One country is said to have an absolute advantage over another in the production of a particular good if it can produce that good using smaller quantities of resources than can the other country. Comparative advantage is the force that generates international trade. One country is said to have a comparative advantage over another in the production of a particular good if it produces that good less inefficiently than the other country. The law of comparative advantage applies even if one country is at an absolute disadvantage relative to another country in the production of every good. Both countries gain from trade even if one of them is more efficient than the other in producing everything. The Law of Comparative Advantage 3

9. Airplanes vs. T-shirts Why produce airplanes ?

10. Airplanes vs. T-shirts

11. Why produce airplanes ? –The U.S. aircraft makers have a comparative advantage in producing airplanes: –The world price line tells us that the world opportunity cost of producing an airplane is $100 million. –The U.S. supply curve shows that the U.S. opportunity cost of producing a plane is less than $100 million for all planes up to the 800th one. The Law of Comparative Advantage 3

12. Why import T-shirts? Airplanes vs. T-shirts

13. Why import T-shirts? Airplanes vs. T-shirts

14. Gains from Trade and the PPF – We can use the PPF to show the gains from international trade. – Production Possibilities in the United States and China – Suppose that the United States produces only two goods: communication satellites and sports shoes – Suppose that China produces these same goods. The Law of Comparative Advantage 3

15. 15 Gains from Trade and the PPF Satellites vs. Shoes

16. –With no trade, China produces 2 satellites and no shoes. –By specializing in producing shoes (the good in which it has a comparative advantage) and trading with the United States, China has 10 million pairs of shoes and 3 satellites. –China’s gains from trade are 10 million pairs of shoes and 1 satellite. Gains from Trade - China The Law of Comparative Advantage 3

17. –With no trade, the United States produces 5 satellites and 50 million pairs of shoes. –By specializing in producing satellites (the good in which it has a comparative advantage) and trading with China, the United States has 90 million pairs of shoes and 7 satellites. –The U.S. gains from trade are 40 million pairs of shoes and 2 satellites. Gains from Trade – the U.S. The Law of Comparative Advantage 3

18. Dynamic Comparative Advantage …through Learning-by-doing. Learning-by-doing occurs when people become more productive as a result of repeatedly performing the same task or producing a particular good or service. Can China export something else than T-shirts? 4

19. EU’s comparative advantage A certain degree of complementarity + Exception: textiles and clothing products - Exception: the manufacture of transport equipment and machinery

20. China’s comparative advantage Revealed comparative advantage (RCA) analysis: The Chinese position in international trade is improving. From: Resource-intensive, lowtech and labour-intensive products To: High-tech products (machinery and equipment)

21. China: Technology-driven exports to the EU are increasing their shares From: Industrial goods manufactured with cheap and low- skilled labour. To: Technology-driven high-tech products. China’s dynamic upgrading of its industrial structures. The Chinese challenge has become much more complex than could be expected just a few years ago. Technology driven business Labour Intensive Industries

22. – Governments restrict trade to protect industries from foreign competition by using two main tools: Tariffs Nontariff barriers – A tariff is a tax on a good that is imposed by the importing country when an imported good crosses its international border. – A nontariff barrier is any action other than a tariff that restricts international trade. For example, a quota, export subsidy. Trade Restrictions 5

24. The effects of tariff

25. Rise in Price of a T-shirt The price of a T-shirt rises by 50 percent from $5 to $7.50 a shirt. Decrease in Purchases The quantity bought decreases from 50 million to 25 million a year. Increase in Domestic Production The higher price stimulates domestic production, which increases from zero to 10 million shirts a year. Consequences of tariff barriers Trade Restrictions 5

26. Decrease in Imports –The quantity imported from 50 million to 15 million a year, a decrease of 35 million shirts. Tariff Revenue –The government collects tariff revenue of $2.50 per shirt on the 15 million shirts imported, a tariff revenue of $37.5 million a year Consequences of tariff barriers Trade Restrictions 5

27. U.S. Consumers Lose – The opportunity cost of T-shirt is $5. – But Americans pay $7.50 for a T-shirt— $2.50 more than the opportunity cost of a shirt. – U.S. consumers are willing to buy 50 million shirts a year at the opportunity cost. – So the tariff deprives people of shirts that they are willing to buy at a price equal to its opportunity cost. Consequences of tariff barriers Trade Restrictions 5

28. Nontariff Barriers Quota – A specified maximum amount of a good that may be imported in a given period of time. How a Quota Works – With free trade, Americans pay $5 a T-shirt and import 50 million T-shirts a year. – Suppose the U.S. government sets a quota on imported T-shirts at 15 million a year. Trade Restrictions 5

29. The effects of quota

30. Health, Safety, and Other Nontariff Barriers Thousands of detailed health, safety, and other regulations restrict international trade. Some examples are: –Food imports into the United States must meet Food and Drug Administration’s standards. –The EU bans imports of genetically modified foods such as U.S. soybean and Canadian granola. –Australia bans imports of Californian grapes to protect its grapes from a virus in California. Trade Restrictions 5

31. Three Arguments for Protection  The national security argument  The infant-industry argument  The dumping argument Arguments for Protection 6

32. The Infant-Industry Argument – The argument that it is necessary to protect a new industry to enable it to grow into a more mature industry that can compete in world markets. – Valid only if the benefits of learning-by-doing not only accrue to the owners and workers of the firms in the infant industry but also spill over to other industries and parts of the economy. Arguments for Protection 6

33. The National Security Argument The argument that a country must protect industries that produce equipment and armaments and those on which the defense industries rely on for their raw materials. This argument does not withstand close scrutiny. –In a time of war, all industries contribute to national defense. –To increase the output of a strategic industry, it is more efficient to use a subsidy rather than a tariff or quota. Arguments for Protection 6

34. The Dumping Argument – Dumping occurs when a foreign firm sells its exports at a lower price than its cost of production. – The argument is that a firm that wants to become a global monopoly might try to eliminate its foreign competitors by dumping. – Once it has a global monopoly, it will raise its price. – Dumping is usually justification for temporary countervailing duties. Arguments for Protection 6

35. Fatally Flawed Arguments for Protection Saves Jobs – The argument is that protection saves jobs because when we buy shoes from Brazil or shirts from Taiwan, U.S. workers lose their jobs. Allows Us to Compete with Cheap Foreign Labor – The argument is that with the removal of protective tariffs in U.S. trade with Mexico jobs rushing to Mexico would make a “giant sucking sound.” Arguments for Protection 6

36. Brings Diversity and Stability –The argument is that protection brings a diversified economy—an economy that fluctuates less than one that produces only a few goods and services. Penalizes Lax Environmental Standards –The argument is that many poor countries, such as Mexico, do not have the same environmental standards as the United States, so we cannot compete without tariffs. Arguments for Protection 6

37. Protects National Culture The argument that is commonly heard in Canada and Europe is that free trade in books, magazines, movies, and television programs means U.S. domination and the end of local culture. Prevents Rich Countries from Exploiting Developing Countries The argument is that if we trade with developing countries in which the wage rate is low, we increase the demand for the goods they produce and so increase the demand for their labor. Arguments for Protection 6

38. …More reasons (developing countries) Tariff revenue In some developing countries, governments cannot use income taxes and sales taxes because financial record-keeping is poor. In these countries, international trade transactions are well recorded, so governments use tariffs on imports to raise revenue. Rent seeking Rent seeking is lobbying and other political activity that seeks to capture the gains from trade. Free trade increases consumption possibilities on the average, but not everyone shares in the gains. Free trade brings benefits to some and costs to others. The uneven distribution of benefits and costs is the principle source of impediment to freer international trade. Arguments for Protection 6

39. From: http://encarta.msn.com/encyclopedia_1741588397_2/Globalization.html V. The Global Economy

40. Summary V The Global Economy 5.1 International trade and comparative advantage 5.2 MNCs and foreign direct investment – foreign firms in China vs. Chinese overseas investment

41. 1.Theories of internationalization 1.1 Multinational corporations 1.2 Why do firms internationalise? 1.3 What determines firm performance in a globalised economy? 1.4 MNCs and Developing Countries 2. FDI and MNCs in China 3. Globalisation of Chinese firms 5.2 MNCs and FDI – Foreign Firms in China vs. Chinese Overseas Investment

42. Growth and size of MNCs -1 45 000 MNCs in the world. 1/3 of the total world trade ($2trillion dollars) Also look at the share of manufacturing produced by foreign enterprises. 1.1 Multinational Corporations Theories of Internationalisation 1

43. Growth and size of MNCs -2 Of the 100 largest economies in the world today, 51 are corporations and 49 are nation states The combined annual sales of General Motors and Ford are higher than the GDP of all sub-Saharan Africa Almost all primary commodities, such as coffee or cotton, are controlled by six or less companies globally 1.1 Multinational Corporations Theories of Internationalisation 1

44. Comparison of the 10 largest multinational corporations (by gross revenue) and selected countries (by GDP): 2002 Comparison of the 10 largest multinational corporations (by gross revenue) and selected countries (by GDP): 2002

45. 1. Product Level (Raymond Vernon) – Product Cycle Theory 2. Firm Level Reactive Motives Decline in domestic market Intensity of competition at home Excess capacity Business incentives Proactive Motives Economies of scale Economies of scope Management attitude Growth motive Control intangible assets (Richard Caves) 1.2 Why do firms internationalise? Theories of Internationalisation 1

46. 3. Home country level – Resource endowments – Tax policy – Transfer pricing: prices paid for goods exchanged between affiliates of an MNC. MNCs manipulate transfer prices to transfer profits out of high tax countries to low tax countries and thereby avoid taxes. Manipulation is possible because intangible assets don't have a market price. 4. Host country level – Tariffs and trade barriers – Government investment policies – Exchange rate policy 1.2 Why do firms internationalise? Theories of Internationalisation 1

47. The Ressource-based theory Competence-based theory Contingency theories 1.3 What determines firm performance in a globalised economy? Theories of Internationalisation 1

48. Contingency Theories Theories of Foreign Direct Investment - Dunning FactorsInternationalisationFDI OwnershipWhy? What ownership advantages does the firm have? Internalisati on how Which is the best approach to internalisation LocationWhere?Which countries?

49. The scale of MNC investment in developing countries Advantages to host country –the saving gap the importance of development finance the contribution of saving to growth –the foreign exchange gap –public finance gap –skills and technology gaps 1.4 MNCs and Developing Countries Theories of Internationalisation 1

50. Disadvantages to host country –MNCs may drive local firms out of business –limited demand for local components –repatriation of profits –transfer pricing and effects on tax revenues competition between developing countries to attract MNCs –distorting the whole pattern of development increasing gap between rich and poor introducing consumerist values What can developing countries do? 1.4 MNCs and Developing Countries Theories of Internationalisation 1

51. 1. Theories of internationalization 1.1 Multinational corporations 1.2 Why do firms internationalise? 1.3 What determines firm performance in a globalised economy 1.4 MNCs and developing countries 2. FDI and MNCs in China 3. Globalisation of Chinese firms 5.2 MNCs and FDI – foreign firms in China vs. Chinese overseas investment

52. FDI inflows in the world ($ millions) FDI and MNCs in China 2

53. 2

54. Quick expanding in the 1990s Average growth rate of realised FDI value: 27.3% Average growth rate of contractual FDI value: 42.6% Word’s No. 1 in terms of the utilized FDI, before the USA By the end of 2002, 424 196 foreign-invested enterprises in China With a total foreign investment of US$828.06 billion Source: www.moftec.gov.cn US$ 527 Billion US$828 Billion FDI and MNCs in China 2

55. Dominating Position in Asia Region FDI Inflows to Developing Asia, 1980 and 2000, % Source: Asian Development Outlook, 2003, p.15 China and Hong Kong represented 77% of the FDI inflows in ASIA FDI and MNCs in China 2

56. 2

57. About 20% directly from developed countries (USA, JP, UK, GE, FR) Explanation on the FDI from HK and Virgin Islands (Cayman Islands) Top 10 Investors in China for 2002 Source: www.moftec.gov.cn FDI and MNCs in China 2

58. Top 10 Investors in China for 2004 FDI and MNCs in China 2

59. Why HK and Virgin Isles? The top 5 countries/regions investing in China in 2002 1. Hong Kong (US$17.861 billion) 2. Virgin Islands (US$6.17 billion) 3. U.S. (US$5.424 billion) 4. Japan (US$4.19 billion) 5. Taiwan Province (US$3.971 billion) FDI and MNCs in China 2

60. (till 2002) Number of projects Contractu al FDI Manufacturing Industry 73,15%63,32% Real Estate, Social Service * 10,72%21,87% Wholesale, Retailing and Catering 5,03%3,20% Construction 2,27%2,73% Transport, Warehousing, Post and Telecommunication * 1,11%2,27% Agriculture, Forestry, Animal, Husbandry & Fishery 2,88%1,90% Health care, sports and social welfare * 0,26%0,62% Scientific research and technical services 0,69%0,40% Education, culture, art, broadcasting and film industry 0,33%0,28% Other Sectors 3,54%3,42% Industrial Composition of FDI Source: www.moftec.gov.cn Dominating investment to the manufacturing industry FDI and MNCs in China 2

61. Pattern of FDI Equity joint venture has the lion’s share Wholly owned FDI soaring to 37% FDI and MNCs in China 2

62. year 2002 % Actual utilized FDI/GDP4.3 Total fixed asset investment10.1 National industrial value-added25.7 National tax incoming20.4 Export value52.2 Labour force11 Source: www.mofcom.gov.cn Contribution of FDI to the Chinese Economy FDI and MNCs in China 2

63. Top 10 MNCs in China, 2002 By sales revenue (2001-2002) 1. Tianjin Motorola Electronics Co. Ltd. 2. SAIC-Volkswagen Sales Co. Ltd. 3. Shanghai Volkswagen Car Co. Ltd. 4. Beijing Capital-Nokia Mobile Telecommunications Co. Ltd. 5. FAW-Volkswagen Car Co. Ltd. 6. FAW-Volkswagen Sales Co. Ltd. 7. Legend (Beijing) Co. Ltd. (HK listed company, strategic alliances with Intel and Microsoft) 8. Huaneng Power International Inc. (USA and HK listed company) 9. Shanghai Siemens Mobile Telecommunication Co. Ltd. 10. Nanjing Ericsson Mobile Telecommunication Co. Ltd. Source: http://www.china.org.cn/ FDI and MNCs in China 2

64. Top 10 MNCs in China, 2004 FDI and MNCs in China 2

65. China’s Advantages as Export Platform Low labour cost At $0.62 – compares well to most Despite rising productivity, surplus labour and lack of independent trade unions will likely keep lid on wages Good infrastructure Convenient logistics in Coastal Areas Critical mass of factories, subcontractors, specialized vendors Incentive policies Source: Pierre Laliberté, 2005, China’s entry in the world economy, Prospects and Challenges. March, Canadian Labour Congress. FDI and MNCs in China 2

66. China’s Comparative Disadvantages Legal system ineffective to enforce contracts (10% of judges have legal training…) Lack of Patent Protection despite official commitment “If it can be reversed engineered, it will…” - Thomas Boam, Minister-Counsellor, U.S. Embassy Electric Power bottlenecks + Environmental costs rising FDI and MNCs in China 2

67. Threats & Opportunities for other countries Threats 1. Competition on attracting FDI: diverted to China 2. Asian counties: concerned about losing competitive position in some labour-intensive exports (e.g., textiles and apparel) Realities 1. The world’s largest recipient of FDI, but not totally foreign investment 2. 70% of exports: labour-intensive goods (garments, toys, shoes, and furniture). Manufacturing wages are about 5% of the US average, and 10% of those in some neighbouring Asian economies Opportunities 1.Increasing export to China, other factors to attract FDI 2.Low wage vs. high productivity FDI and MNCs in China 2

68. 1.Theories of internationalization 1.1 Multinational corporations 1.2 Why do firms internationalise? 1.3 What determines firm performance in a globalised economy? 1.4 MNCs and Developing Countries 2. FDI and MNCs in China 3. Globalisation of Chinese firms 5.2 MNCs and FDI – foreign firms in China vs. Chinese overseas investment

69. The competitive strategies At least three categories of competitive strategies: (1)Cost advantage strategy (2)Niche advantage strategy (3)"Global product" advantage strategy Globalisation of Chinese firms 3

70. Cost advantage strategy Description: Cost advantage through high volume production of standardised goods and/or lower labour costs in home countries Practice: OEM, depend on major customers for technology and expertise, Process innovation, Example: Footwear production, electronic products Critical Points: lack the financial strength, marketing expertise to move to original design and product development Globalisation of Chinese firms 3

71. Niche advantage strategy Description: Niche advantage through flexible batch production of goods and rapid response to market needs; Practice: lean (and mean?) production practices. By being highly adaptive and flexible, very responsive to market demands and fluctuations. Example: Taiwanese firms in PC and keyboard manufacturing, Other TNCs in Southeast Asia, in service industries (e.g. trading and distribution, finance, insurance, real estate, business services and telecommunications). Critical Points: Asian countries characterised by imperfect market conditions and host government regulations (especially for service industries). Globalisation of Chinese firms 3

72. "Global product" advantage strategy Description: "Global product" advantage through intensive technological innovations, extensive marketing and brand name development. Truly global players. Practice: strong brand names and technological innovations, immense financial assets and globally integrated networks of operations. Example: From Taiwan: Acer, Tatung, From Singapore: IPC, Creative Technology, CDL, from South Korea: Hyundai, Samsung, LG; from Hong Kong: Shangri-la. Critical Points: strong support from their developmental state at home. Globalisation of Chinese firms 3

73. The organization of TNC from emerging economies Jointventures with minority shares in equity have been the most preferred mode of market entry Vertical integration as the conventional forms of market entry Parent-subsidiary relationship: loose, fluid and informal after the initial supply of core technology and management from the parent company, the foreign subsidiaries of these TNCs may usually be given more autonomy over time. Globalisation of Chinese firms 3