Labor and Capital Mobility ch. 15

Capital Mobility - definitions International mobility of capital: foreign direct investment (FDI) International capital flows in which a firm in one country creates or expands subsidiary into another country flow of funding provided by an investor or lender (usually a firm) to establish or acquire a foreign company or expand to finance an existing foreign company that the investor owns and controls key distinction is the degree to which an investor can control or influence the management of the company a rule of thumb: if someone owns at least 20% of a firm, they can have the ability to influence management the agreed intl standard is 10% ownership : FDI is any flow of lending to, or purchase of ownership in, a foreign firm in which the investor (usually a firm) has (or gains) ownership of 10% or more of the foreign firm.

Capital Mobility - definitions FDI: involves the transfer of capital resources and the acquisition of control Foreign subsidiary: If US company purchases more than 50% of the shares outstanding in a French company -- US company has controlling interests Branch plant: If US builds a plant in France -- there is ownership and control over this facility Note: FDI is usually discussed in the context of the multinational corporation (MNC) production is taking place in plants located in two or more countries, but under the supervision and general direction of the headquarters located in one country.

Capital Mobility - definitions Multinational corporation (MNC) or Multinational enterprise (MNE) a firm that owns and controls operations in more than one country is an MNE Ex: production is taking place in plants located in two or more countries, but under the supervision and general direction of the headquarters located in one country. parent firm: in the MNE is the headquarters or base firm located in the "home" country foreign affiliates (subsidiary or branch): parent firm has one or more located in the "host" country

Capital Mobility - definitions Multinational enterprise (MNE) characteristics MNE operates in 2 or more countries via branches or subsidiaries over which it has effective control 10% or more of ownership in stock is deemed to be sufficient for direct control of business operations. International borrowing and lending sometimes occurs between a parent company and its subsidiary. MNE: Not just a vehicle for transferring capital MNE transfer other "things" to foreign affiliates, like intangible assets (proprietary technology, brand names, marketing capabilities, trade secrets, managerial practices).

Fortune 500’s list of world’s largest corporations in 2013 Company Country Revenue ( billions) Royal Dutch Shell Netherlands 481.7 Wal-Mart Stores U.S. 469.2 Exxon Mobil 449.9 Sinopec Group China 428.2 China National Petroleum 408.6 BP United Kingdom 388.3 State Grid 298.4 Toyota Motor Japan 265.6 Volkswagen Germany 247.6 Total 234.3 Source: Fortune Global 500 http://money.cnn.com/magazines/fortune/global500/index.html)

Capital Mobility - definitions MNEs may diversify their operations Vertical integration: a parent MNE establishes foreign subsidiaries to produce intermediate goods or inputs that go into the production of the finished good. Backward integration: includes the extraction and processing of raw materials. Forward integration: in the direction of the final consumer market. Horizontal integration: parent company producing commodity in the source country sets up a subsidiary to produce the identical product in the host country Conglomerate integration: firms that have diversified in non-related markets

Capital Mobility - Extent to which it occurs To measure the importance of MNEs across countries and over time, we typically look at data on FDI as a general indicator Flows of FDI: measure new equity investments and loans within the MNE during a period of time Stock of FDI: measures the total amount of direct investment that exists at a point in time. Stocks are sums of past flows of FDI into which MNE occurs

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Capital Mobility – Why to MNE Exist? 1. Inherent disadvantages lack of knowledge of local laws, customs, procedures, practices and relationships extra cost of initially managing from a distance lack of initial connection to political leaders - could face some hostility

Capital Mobility – Why to MNE Exist? firm-specific advantages ownership of intangible assets A MNE has some expertise that it hopes to exploit in larger markets With firm specific advantages, the question is still Should the firm sell to foreign buyers by exporting from "home" country? Or set up local production in the foreign country to produce and sell locally to foreign buyers? Should the firm license products to local firms in the foreign country so that foreign firms use their advantages of local operations to serve foreign buyers? Or should the firm set up foreign production operations that it owns and controls?

Capital Mobility – Why to MNE Exist? 3. Locational Factors: all of the advantages or disadvantages of producing in one country (home) or in another (foreign country). key to answering question of "export or FDI“? some key locational factors: Comparative advantage Scale economies Ex: High plant-specific costs but low transportation cost may encourage exports (rather than FDI). Ex: Size of the foreign market may not be large enough for production in a foreign market. But this may change if market grows. Gov. barriers to importing into the foreign country Existence of a PTA Transportation costs Host country taxes and subsidies

Capital Mobility – Why to MNE Exist? 4. Internalization advantages The advantages of using an asset within the firm rather than finding other firms to buy, rent or license the asset key to answering question of "license or FDI“? license: an agreement for one firm to use another firm's assets, with restrictions on how the asset can be used, and with payments for the right to use the asset. Internalization occurs because it is more profitable to conduct transactions and production within a single organization than in separate organizations. Reasons for this include Avoiding the transaction costs and risk of licensing an independent firm Technology transfers Vertical integration

Capital Mobility – Why to MNE Exist? 5. Oligopolistic Rivalry Basic idea: MNE are often large firms that have some monopoly power (economies of scale and thus very large or have some intangible asset). They also compete with each other for market share and turf Thus: make their decisions about FDI as part of their strategies for competing

Capital Mobility – MNE and Trade Does MNE increase or decrease trade? case 1: vertical integration with low transportation costs and low trade barriers, FDI can be used to reduce total cost by locating different stages of production in different countries. FDI thus leads to more trade; FDI and trade are complements case 2: horizontal integration FDI and trade are substitutes & need to find a balance between: centralizing production in one or few locations and exporting to achieve scale economies spreading production to many host countries to reduce transportation costs and avoid trade barriers. FDI can still promote or complement trade

Migration - definitions Temporary migration Seasonal workers Permanent migration Immigrant permanently moves to another country and establishes citizenship

© 2013 Cengage Learning. All Rights Reserved © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use