Multinational Enterprises

Multinational Enterprises Tain-Jy Chen June 8, 2011

Multinational Enterprises • Stylized Facts • MNEs and Trade • Effects on Host country • Effects on Source country

I. Stylized Facts Foreign direct investment has grown rapidly throughout the world, particularly since 1980. Developed countries account for the majority of outward FDI, and a large proportion of inward FDI. However, China has become the largest FDI recipient country in recent years. Two-way FDI is common between a pair of developed countries, sometimes even in the same industry. This appears to be the other side of intra-industry trade. 3

I. Stylized Facts Most FDI is horizontal investment. Vertical investment usually occurs in developing countries. MNEs conduct intra-firm trade, which accounts for an increasing proportion of world trade (more than 30%). There is little evidence to show that FDI is related to differences in capital endowment or differences in capital returns between countries. Meanwhile skilled labor endowment is shown to be positively correlated with outward FDI. 4

II. MNEs and Trade Although FDI is accompanied by an outflow or inflow of capital, the movement of capital is not the key feature of FDI. The key feature of FDI is the cross-border application of intangible assets. Intangible assets are characterized by non-rivalry in usage and difficulty to transfer and trade. Therefore intra-firm transfer is the best way to exploit the value of intangible assets. 5

II. MNEs and Trade FDI in developed countries is mostly horizontal, and serves as a means to enter local markets. FDI is a superior entry mode than export because of the service components of trade need to be provided locally. This is true for most service industries and for some manufactures (such as auto) as well. FDI may also used to circumvent trade barriers (tariff jumping FDI). In general, horizontal FDI facilitates trade rather than replaces trade. Example: Coca Cola, banks, McDonald’s. 6

II. MNEs and Trade FDI in developing countries may be horizontal or vertical. The purpose of vertical investment is mainly to access resources in the host country. In this case, FDI is a means to facilitate trade in resources. For example, China has abundant labor, which can be exported if China has appropriate technology to produce labor-intensive goods for export. However, China may not possess this technology, and therefore leaving its abundant resources unexploited. MNEs bring this technology into China to exploit potential gains. China can also import technology to exploit its labor resources, which has been the strategy of some developing countries such as Japan and Korea in the past. Therefore FDI is a substitute for technology trade. The reason for MNEs to prefer FDI is that market for technology is imperfect. 7

II. MNEs and Trade Vertical FDI is often associated with intra-firm trade. The headquarters provides components and parts to enable production at the subsidiaries, which in turn, exports intermediate or finished goods to the source country or third-party countries. The travel of intermediate goods across borders constitutes a large proportion of international trade today. In terms of resource exchange, the source country provides technology and managerial know-how in exchange for labor service of the host country. 8

II. MNEs and Trade There is also FDI aiming at exploring natural resources such as oil or iron ore mining. In this case, MNEs provide capital as well as technology to excavate natural resources. FDI facilitates trade in natural resources. Recently there is also FDI seeking strategic resources such as technology. MNEs invest in overseas R&D centers to acquire local technologies or to access local skilled workers. Because FDI is more risky than export, FDI will not be used as a substitute for export unless trade is impeded. In this sense, FDI is always trade facilitating. The rise of MNEs contributes to the increase in service trade, especially the production related services. 9

II. MNEs and Trade If FDI means cross-country production, it implies that cost savings from overseas production outweigh coordination and transport costs. If FDI means cross-country integration of resources, it implies that some location specific resources can not be accessed without local presence. If FDI means cross-border transfer of knowledge, it implies that such a transfer is only possible within the boundary of firm. 10

III. Effects on Host Country To the extent that foreign capital supplants domestic savings, FDI accelerates domestic capital formation and consequently economic growth. FDI brings capital and new technologies to the host country. FDI creates jobs and increases wages. Empirical evidence shows that MNEs usually pay higher wages than local firms. Whether MNEs transfer technologies to the local economy is debatable. Some argue that MNEs form an enclave and are isolated from the local economy. An enclave is likely to result from institutional differences between the host country and the world economy. An enclave is characterized by lack of local linkage, which deprives the local economy of the opportunity to provide components and parts. 11

III. Effects on Host Country MNEs may not bring the frontier technologies to the host country because of lack of competition — permissive environment. In addition to pure technology transfer, positive spillover effects of FDI may arise from imitation, backward and forward linkages, or sheer competition in the local economy. FDI may “control” the local economy in the sense that it pre-empts the business opportunity of local firms (crowding-out effect). However, this can be prevented by a right competition policy. 12

III. Effects on Host Country FDI may slow down the speed of skill accumulation by narrowing the wage premium for skilled workers. It can speed up the skill accumulation by offering a premium for skilled workers. Empirical evidence points to the latter case. FDI may slow down the speed of technology accumulation by local firms because MNEs take way the premier skilled workers in the host country. 13

IV. Effects on Source Country To the extent that capital outflow diminishes the amount of capital available for domestic investment, outward FDI slows down the speed of capital formation, and therefore economic growth. If FDI is accompanied by a relocation of industrial production, FDI may results in an industrial hollowing-out. Industrial hollowing-out is associated with job losses. Empirical evidence shows little evidence that FDI exports jobs. FDI does change the job structure. In US, FDI resulted in a decrease in unskilled jobs but an increase in skilled jobs (technology and management related). In Sweden, FDI reduced skilled jobs while increasing unskilled jobs. 14

IV. Effects on Source Country FDI may result in a restructuring of the industry, e.g., by horizontal differentiation of products. This occurs when MNEs are broadly based and blessed by brands. Japanese MNEs are good examples. FDI may pushed the source-country industry toward the upstream, particularly when the upstream is characterized by scale economies and capital intensity. Taiwan’s PC and LCD are a typical case. It has been argued that the fact that FDI separates production from R&D will eventually weaken the ability to innovate. Empirical evidence seems to suggest that innovation is more related to market rather than production. 15

IV. Effects on Source Country If overseas markets are large enough, subsidiaries may overtake the headquarters to become the locus of growth. US and China are good examples. The concern for industrial hollowing-out is manufacturing-minded. In fact, FDI often generates service exports, boosting the service sector of the investing country. UK is a classical case of FDI-led industrial hollowing-out, but FDI also sustains UK’s unchallenged position as the world’s financial center. 16

Multinational Enterprises