International Economics By Robert J. Carbaugh 9th Edition Chapter 10: International Factor Movements and Multinational Enterprises

Factor movements & multinational enterprises International movement of factors of production (capital, labor) is a substitute for international trade in goods International capital flows (investment) can substitute for trade in capital-intensive goods Labor mobility can substitute for trade in labor-intensive goods Carbaugh, Chap. 10

Multinational enterprises Factor movements & multinational enterprises Multinational enterprises Various business operations in numerous host countries Headquarters often far from operations Stock ownership and management are usually multi-national Frequently employ vertical integration, horizontal integration, conglomerate structure Carbaugh, Chap. 10

Foreign direct investment Multinational enterprises Foreign direct investment A foreign or multinational firm can buy a controlling interest in a local firm Buy or build new plants or equipment overseas Shift funds abroad to expand a subsidiary Reinvest the earnings of a foreign subsidiary Carbaugh, Chap. 10

Reasons for foreign direct investment Multinational enterprises Reasons for foreign direct investment Demand factors Serve different local markets Respond to market competition Cost factors Access to key raw materials Labor costs Transportation costs Government policies Carbaugh, Chap. 10

Choice between export and FDI Foreign direct investment Choice between export and FDI Carbaugh, Chap. 10

Choice between licensing and FDI Foreign direct investment Choice between licensing and FDI Carbaugh, Chap. 10

International joint ventures Multinational enterprises International joint ventures Two companies can operate a venture in a third country A foreign firm can work with a local company A foreign firm can form a venture with a unit of the local government Carbaugh, Chap. 10

Reasons for international JVs Multinational enterprises Reasons for international JVs Cost sharing - R&D, capital expenditures (in mining and oil, for example) Avoiding restrictions on foreign ownership of local firms (ensuring local participation) Forestalling pressure for protectionism Problems: divided control means success of JV depends on ability of firms to work together Carbaugh, Chap. 10

Effects of an international JV Multinational enterprises Effects of an international JV Carbaugh, Chap. 10

Controversy over multinationals Multinational enterprises Controversy over multinationals Employment Host country may not gain many jobs, foreign managers often brought in; source country worries about losing jobs Technology transfer MNEs are reluctant to share technology with host nations; source country worries about giving away advantage Carbaugh, Chap. 10

Controversy over multinationals (Cont’d) Multinational enterprises Controversy over multinationals (Cont’d) National sovereignty Host country worries about power of MNE to influence affairs; source country worries about ability to regulate MNE activities elsewhere Balance of payments MNE investments and profits (internal transfers) have impacts on the payments status of both source and host nations Carbaugh, Chap. 10

Controversy over multinationals (Cont’d) Multinational enterprises Controversy over multinationals (Cont’d) Taxation Source countries may have difficulty taxing MNE income stemming from foreign operations Tax rate differences may discourage investment at home Transfer pricing Both host and source governments worry that MNEs may illegally manipulate prices paid between subsidiaries to avoid taxes Carbaugh, Chap. 10

Transfer pricing illustrated Multinational enterprises Transfer pricing illustrated Germany (tax rate 48%) Computer produced by parent firm for $2000. Sold to Irish subsidiary for $2000. German tax paid: $0. Ireland (tax rate 4%) Irish subsidiary resells the same computer to US subsidiary for $2500, earning $500 profit. Irish tax paid: $20. United States (tax rate 34%) US subsidiary sells computer at cost, for $2500. No profit is earned. US tax paid: $0. Irish subsidiary then lends money to US subsidiary for expansion Carbaugh, Chap. 10

Migration Tends to equalize wage rates between countries International factor movements Migration Tends to equalize wage rates between countries Shifts distribution of income between capital and labor Other concerns: Fiscal drain from immigration Brain drain from developing countries Impact of illegal migration Wider gulf between skilled and unskilled workers Carbaugh, Chap. 10

Effects of labor migration International factor movements Effects of labor migration United States Mexico Carbaugh, Chap. 10