Economics for Managers

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. 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 Summary

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

6. 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

7. 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

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

9. 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. The Law of Comparative Advantage 3 Gains from Trade - China

10. 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. The Law of Comparative Advantage 3 Gains from Trade – the U.S.

11. 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

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

13. 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)

14. China: Technology-driven exports to the EUare increasing their shares Labour Intensive Industries Technology driven business • 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.

15. Governments restrict trade to protect industries from foreign competition by using two main tools: Tariffs Nontariff barriers Atariff is atax on a good that is imposed by theimporting country when an imported good crossesits international border. Anontariff barrieris any action other than a tariff that restricts international trade. For example, a quota, export subsidy. Trade Restrictions 5

16. 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

17. 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

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

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

20. 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 Summary

21. 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

22. 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. Theories of Internationalisation 1.1 Multinational Corporations 1

23. Theories of Internationalisation 1 1.1 Multinational Corporations • 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

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

25. 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) Theories of Internationalisation 1 1.2Why do firms internationalise?

26. 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 Theories of Internationalisation 1 1.2Why do firms internationalise?

27. 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 Theories of Internationalisation 1 1.4 MNCs and Developing Countries

28. 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? Theories of Internationalisation 1 1.4 MNCs and Developing Countries

29. 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

30. 2 FDI and MNCs in China FDI inflows in the world($ millions)

31. 2 FDI and MNCs in China

32. Source: www.moftec.gov.cn 2 FDI and MNCs in China Quick expanding in the 1990s US$828 Billion US$ 527 Billion • 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

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

34. 2 FDI and MNCs in China

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

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

37. 2 FDI and MNCs in China 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)

38. 2 FDI and MNCs in China Industrial Composition of FDI (till 2002) Source: www.moftec.gov.cn Dominating investment to the manufacturing industry

39. 2 FDI and MNCs in China Pattern of FDI Equity joint venture has the lion’s share Wholly owned FDI soaring to 37%

40. 2 FDI and MNCs in China Contribution of FDI to the Chinese Economy year 2002 Source: www.mofcom.gov.cn

41. 2 FDI and MNCs in China 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/

42. 2 FDI and MNCs in China Top 10 MNCs in China, 2004

43. 2 FDI and MNCs in China • 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.

44. 2 FDI and MNCs in China • 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

45. 2 FDI and MNCs in China 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 • Increasing export to China, other factors to attract FDI • Low wage vs. high productivity

46. 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

47. Globalisation of Chinese firms At least three categories of competitive strategies: Cost advantage strategy Niche advantage strategy "Global product" advantage strategy 3 The competitive strategies

48. Globalisation of Chinese firms 3 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

49. Globalisation of Chinese firms 3 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).

50. Globalisation of Chinese firms 3 "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.