2 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 countryflow 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 controlskey distinction is the degree to which an investor can control or influence the management of the companya rule of thumb: if someone owns at least 20% of a firm, they can have the ability to influence managementthe 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.
3 Capital Mobility - definitions FDI: involves the transfer of capital resources and the acquisition of controlForeign subsidiary: If US company purchases more than 50% of the shares outstanding in a French company -- US company has controlling interestsBranch plant: If US builds a plant in France -- there is ownership and control over this facilityNote: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.
4 Capital Mobility - definitions Multinational corporation (MNC) or Multinational enterprise (MNE)a firm that owns and controls operations in more than one country is an MNEEx: 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" countryforeign affiliates (subsidiary or branch): parent firm has one or more located in the "host" country
5 Capital Mobility - definitions Multinational enterprise (MNE) characteristicsMNE operates in 2 or more countries via branches or subsidiaries over which it has effective control10% 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 capitalMNE transfer other "things" to foreign affiliates, like intangible assets (proprietary technology, brand names, marketing capabilities, trade secrets, managerial practices).
6 Fortune 500’s list of world’s largest corporations in 2013 CompanyCountryRevenue( billions)Royal Dutch ShellNetherlands481.7Wal-Mart StoresU.S.469.2Exxon Mobil449.9Sinopec GroupChina428.2China National Petroleum408.6BPUnited Kingdom388.3State Grid298.4Toyota MotorJapan265.6VolkswagenGermany247.6Total234.3Source: Fortune Global 500
7 Capital Mobility - definitions MNEs may diversify their operationsVertical 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 countryConglomerate integration: firms that have diversified in non-related markets
8 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 indicatorFlows of FDI: measure new equity investments and loans within the MNE during a period of timeStock 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
10 Capital Mobility – Why to MNE Exist? 1. Inherent disadvantageslack of knowledge of local laws, customs, procedures, practices and relationshipsextra cost of initially managing from a distancelack of initial connection to political leaders - could face some hostility
11 Capital Mobility – Why to MNE Exist? firm-specific advantagesownership of intangible assetsA MNE has some expertise that it hopes to exploit in larger marketsWith firm specific advantages, the question is stillShould 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?
12 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 advantageScale economiesEx: 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 countryExistence of a PTATransportation costsHost country taxes and subsidies
13 Capital Mobility – Why to MNE Exist? 4. Internalization advantagesThe advantages of using an asset within the firm rather than finding other firms to buy, rent or license the assetkey 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 includeAvoiding the transaction costs and risk of licensing an independent firmTechnology transfersVertical integration
14 Capital Mobility – Why to MNE Exist? 5. Oligopolistic RivalryBasic 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 turfThus: make their decisions about FDI as part of their strategies for competing
15 Capital Mobility – MNE and Trade Does MNE increase or decrease trade?case 1: vertical integrationwith 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 complementscase 2: horizontal integrationFDI and trade are substitutes & need to find a balance between:centralizing production in one or few locations and exporting to achieve scale economiesspreading production to many host countries to reduce transportation costs and avoid trade barriers.FDI can still promote or complement trade
16 Migration - definitions Temporary migrationSeasonal workersPermanent migrationImmigrant permanently moves to another country and establishes citizenship