1. INTERNATIONAL TRADE AND FOREIGN DIRECT INVESTMENT
Chapter 2

2. Introduction
International trade and investment have become fundamental to most people’s lives. For example:
The food we eat
The clothes we wear
The vehicles we drive
The electronic goods
And our jobs are dependent on:
Exports
Imports
Foreign investment

3. Three ways of doing international business:
1) International trade
Importing and exporting goods and services
2) Foreign direct investment (FDI)
Purchase of sufficient stock in a firm to obtain significant management control
3) Foreign sourcing
The overseas procurement of raw materials, components, and products

4. Volume of international Trade
As can be seen in the Figure 2.1, international trade has become a critical factor in the economic activity on many, if not most, of the countries of the world.

5. Domestic market or the global market?
Foreign sales averaged 56.6% of the total sales of the largest 100 global companies (2008).
Ratio of income from foreign sales to total income averaged 51.5% for these large multinationals.
Without sales and profits generated from foreign operations, the competitiveness of many of these companies would be seriously damaged and some of them might be unable to remain business.

6. Leading exporters and importers
Generally, the largest exporters and importers are the same countries. It means that once a country participates in the global trade, its imports and exports increase.
Generally, services trade is one-third of the merchandise trade.
Trade regionalizes in time. That is, members of the regional blocks trade more with eachother.

7. Which nations account for the most exports and imports?
Table 2.1 presents the world’s 10 largest nations in terms of exports and imports of merchandise and of services.

8. Direction of Trade
What are the destinations of these merchandise exports?
Are the manufactured goods only exported by industrialized nations to the developing nations n return for the row material?
More than half of the exports from developing nations do go to developed countries.
Approximately, 70 % of exports from developed economies go to the other industrialized nations, not to developing countries.

9. The Increasing Regionalization of Trade
Although the direction of trade frequently changes over time among nations or regions of the world, the overall level of world trade continues to be dominated by trade that occurs with-not between-nations.
This regionalization of trade is reinforced by the development of expanded regional trade agreements:
Association of Southeast Asian Nations (ASEAN).
Mercosur in South America
Europe Union (EU)
North American Free Trade Agreement (NAFTA)
And …
Overall, there are more than 200 regional trade agreements in operation worldwide.

10. Major trading partners:
They are those countries where the firm has affiliates.

11. Why focus on major trading partners?
1) The business climate in the importing nation is relatively favorable.
2) Export and import regulations are not insurmountable.
3) No strong cultural objections to buying that nation’s goods.
4) Satisfactory transportation facilities have already established.
5) Import channel members (merchants, banks, custom brokers, etc) are experienced in handling import shipments from the exporter’s area.
6) Foreign exchange to pay for the exports is available.
7) The government of a trading partner may be applying pressure on importers to buy from countries that are good customers for that nation’s exports.

12. Foreign investment

13. Foreign Investment
1. Portfolio Investment Purchase of stocks* and bonds** solely for the purpose of obtaining a return on the funds invested. 2. Direct investment Investors participate in the management of the firm in addition to receiving a return on their money.
*Stock: A stock (also known as "shares" and "equity) is a type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings.
**Bond: A bond is a fixed income investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.

14. Foreign Investment
Foreign investor in the stock of a domestic company generally are treated as direct investment when: the investor’s equity participation ratio is 10 percent or more (>=10%). In contrast, are classified as portfolio investments: deals that do not result investor’s obtaining at least 10 percent of the shareholdings (<10%).

15. Foreign Direct Investment (FDI)
The outstanding stock of FDI – is the book value or the value of total outstanding stock.
The total FDI worldwide is $12.5 trillion (2006). The major investor countries are US ($2.4 billion), UK, and France.
The proportion of FDI accounted for by the US declined more than 47% between , from 36% to 19%.
The proportion of FDI accounted for by the EU increased from 36% to 52%.
The FDI by M-BRIC countries are increasing.
Overseas Chinese investors have more than $1 trillion assets abroad (in Malaysia, Thailand, Indonesia, Vietnam, Philippines, and Hong Kong). They are the major source of investment capital flowing into China.

16. Foreign Direct Investment (FDI)

17. Annual outflows of FDI
It is the amount invested each year into other nations.
(billion$)
World
Developed countries
Developing countries
USA EU UK
Germany

18. Annual inflows of FDI
It shows the yearly amount of FDI coming intı the country.
(billions$)
World
Developed count ,
Developing count US EU UK
China(+Hong Kong)

19. Foreign Direct Investment (FDI)
Much of outward FDI has been associated with mergers and acquisitions.
Two-thirds of the value of corporate investments made in US from abroad have been spent to acquire going companies rather than to establish new ones.
Similarly, the majority of American investments into foreign markets have gone to the acquisition of going companies. What are the reasons?

20. Foreign Direct Investment (FDI)
Much of inward investment has gone to mergers and acquisitions made by companies whose businesses are confronting competition and consolidation globally.
The small nation of Singapore (population 3 million) received almost as much foreign investment as the entire African continent did during 1985 – 2009.
A particularly important trend is the proportion of Asian FDI that has been directed to China and its territories.

21. Foreign Direct Investment (FDI)
Much of inward investment has gone to mergers and acquisitions made by companies whose businesses are confronting competition and consolidation globally.
The small nation of Singapore (population 3 million) received almost as much foreign investment as the entire African continent did during 1985 – 2009.
A particularly important trend is the proportion of Asian FDI that has been directed to China and its territories.

22. Foreign Direct Investment (FDI)
Level and Direction of FDI-If a nation is continuing to receive appreciable amounts of foreign investment, its investment climate must be favorable.
This means that the political forces of the foreign environment are relatively attractive and that the opportunity to earn a profit is greater there than elsewhere.

23. Does trade lead to FDI? Historically, FDI has followed foreign trade.
One reason is that trade is less costly and less risky than making a direct investment into foreign markets.
Also, management can expand the business in small increments rather than through the large amounts of investment and market size that a foreign production facility requires.

24. As a result, FDI and trade are closely interlinked.
Does trade lead to FDI?
Why do many international firms disperse the activities of their production systems to locations close to available resources?
Fewer government barriers to trade
Increased competition from globalizing firms
New production
Communications technology
Then integrate the entire production process either regionally or globally.
As a result, FDI and trade are closely interlinked.

25. Why enter foreign markets?
1) Increase profits and sales
Enter new markets – managers are always under pressure to increase profits and sales, and when they face a mature, saturated market at home, they search for new markets in other countries (especially when the incomes and population in these markets are growing).
New market creation: Find potential new markets.
Preferential trading arrangement: An agreement by a small group of nations to establish free trade among themselves while maintaining trade restriction with other nations.
Faster growing markets: Some new markets are growing faster than the home market.
Improved communications: Firms can communicate faster and cheaper with the customers.

26. Why enter foreign markets?
Obtain greater profits – It can be achieved through increasing revenues and/or decreasing costs.
-Greater revenue: If the firm’s competitors have not entered the market, the firm may ask higher prices for its goods.
-Lower cost of goods sold: Lower taxes, lower interest rates, lower wages, subsidized investments, allocation of public land for the investments, export incentives, etc.
-Higher overseas profits as an investment motive: More than 90% of global companies obtain greater profits overseas.

27. Why enter foreign markets?
Test market – A global market will test-market in foreign location that is less important to the company than its home market and major overseas markets.
Management’s thinking is that any mistakes made in the test-market should not adversely affect the firm in any of its major markets.

28. Why enter foreign markets?
2) Protect markets, profits, and sales
Protect domestic market – A firm will go abroad to protect its home market.
-Follow customers overseas: Service companies (like accounting, advertising, marketing research, banking, law) will establish foreign operations in markets to prevent competitors from gaining access to those accounts. They know that once a competitor gains one of the subsidiary’s management, it can get access to all the accounts.

29. Why enter foreign markets?
Attack in competitor’s home market –A firm may set up an operation in the home country of a major competitor with the idea of keeping the competitor so occupied defending that market that it will have less energy to compete in the firm’s home country.

30. Why enter foreign markets?
Using foreign production to lower costs – A company may go abroad to protect its domestic market when it faces domestic competition from low-priced imports. It can enjoy low-cost labor, raw materials, and energy.
- export processing zones: It is where, mostly foreign manufacturers, enjoy absence of taxation, import regulations. It is a government designated zone in which workers are permitted to import parts and materials without paying import duties, as long as these imported items are then exported once they have been processed and assembled. In-bond plants (maquiladoras), for example, are production facilities in Mexico that temporarily import raw materials, components, or parts duty-free to be manufactured, processed, or assembled with less expensive local labor, after which the finished or semi-finished product is exported.

31. Why enter foreign markets?
Protect foreign markets – Changing the method of going abroad from exporting to overseas production may be necessary to protect foreign markets.
- Lack of foreign exchange: There may be foreign exchange scarcity in the local market. In this case, if the advantages outweight the disadvantages, the firm may decide to produce locally to protect the market.
- Local production by competitors: The firm may decide to produce locally, if the demand for the product justifies that investment, especially if the competitors are investing in that market.
- Downstream markets: A number of OPEC countries have invested in refining and marketing outlets to guarantee a market for their crude oil at more favorable prices.
- Protectionism: When the government sees that local industry is threatened by imports, it may impose import barriers to protect the local firms. The exporter then may be forced to invest in the market.

32. Why enter foreign markets?
Guarantee supply of raw materials – Most of the raw materials are in the developing countries. Japan and Europe are totally depended on imported raw materials. Even the US depends on the imported aluminum, chromium, manganese, nickel, tin, and zinc. Iron, lead, tungsten, copper, potassium, and sulfur will soon be added to the list. To ensure continuous supply, firms have to invest in the developing countries with resources.

33. Why enter foreign markets?
Acquire technology and management know-how – Many US firms invest in foreign markets to acquire technological and management know-how. Herbal medicine is a production line learned from the Chinese, for example.

34. Why enter foreign markets?
Geographic diversification – Many companies have chosen geographic diversification as a means of maintaining stable sales and earnings when the domestic economy or their industry goes into a slump. Often, in other parts of the world economic growth makes a peak.

35. Why enter foreign markets?
Satisfy management’s desire for expansion – Stockholders and financial analysts expect the firm to grow, so managers feel obliged to grow, even at times when growing makes little economic sense. When it becomes difficult to grow in the domestic market, the firm invests in other countries.

36. HOW TO ENTER FOREIGN MARKETS?
Exporting
Turnkey projects
Foreign manufacturing

37. Exporting – selling some of the firm’s products in overseas markets

38. Indirect expoting – exporting via home based exporters

39. 1) Manufacturers’ export agents: they sell for the manufacturer 2) Export commission agents: they buy for their overseas customers 3) Export merchants: they purchase and sell on their own account 4) International firms: they buy and sell goods overseas, like mining, petroleum companies.

40. Direct exporting – exports undertaken by the firm producing goods and services.

41. If business expands in export markets, firm follows these steps: Salesman (in the firm) ↓ Export department (in the firm) ↓ Sales company (maybe with channels of distribution)

42. Turnkey projects can be export of technology, management expertise, and in some cases capital equipment.

43. In turnkey projects, the contractor builds the plant, supply the technology, provides suppliers of raw materials and other production inputs, train operating personnel, run the factory for some time and return the factory to the owner.

44. FOREIGN MANUFACTURING 1) Wholly owned subsisidary 2) Joint venture 3) Licensing 4) Franchising 5) Contract manufacturing

45. 1) Wholly owned subsidiary a. Start by building a new plant b
1) Wholly owned subsidiary a. Start by building a new plant b. Acquire a going concern – mostly firms buy an already existing firm. This way it will have one less competitor and an established firm with customers, suppliers, permissions taken. c.Purchase a distribution firm

46. 2) Joint venture a. It can be between a company owned by an international firm and local owners, b.Two international companies come together for the purpose of doing business in a third market, c.A joint venture between an international company and a government firm d.A cooperation between two or more firms for the duration of a project, like a damn, airport, etc.

47. Advantages of joint ventures: By-pass nationalistic feelings Acquire expertise, tax, and other benefits Reduce investment risks

48. Disadvantages of joint ventures: Firms have to share profits Lack of control

49. 3) Licensing is a contractual arrangement in which one firm grants access to its patents, trade secrets, or technology for a fee.

50. 4) Franchising is a form of licensing in which one firm contracts with another to operate a certain type of business under an established name according to specific rules.

51. 5) Contract manufacturing is an arrangement in which one firm contracts with another to produce products to its specifications but assumes responsibility for marketing.

52. Strategic alliances can be established with customers, suppliers, competitors.

53. The purposes of strategic alliances are; to achieve faster market entry and start-up, to gain access to new products, to share costs, resources, and risks.