Ch 10 – International Factor Movements & Multinational Enterprises

1. Ch 10 – International Factor Movements & Multinational Enterprises There's no business like show business, but there are several businesses like accounting. David Letterman

2. Ch 10 – MNE’s Multinational Enterprises (MNE) • Operate in many countries • Conduct various activities relating to their industry • High ratio of foreign to total sales (often 25% or more). • Typically huge corporations • Examples: • Coca Cola and Pepsi • General Electric • Chrysler-Mitsubishi • Ford-Mazda-Nissan • Wal-Mart

3. Ch 10 – MNE’s Forward Vertical Integration Move toward final consumer market, typically distribution, sales or marketing of final goods. Automobile sales Automobile marketing Primary good - Automobile Backward Vertical Integration Production of component parts, or extraction of raw materials (economies of scale possible). Engine parts Steel Multinational Enterprises (MNE) Three Ways MNE’s Diversify • Vertical Integration • Parent company establishes foreign subsidiaries to produce intermediate goods used for production of final goods, or to diversify into more advanced step in production/use of primary good.

4. Ch 10 – MNE’s Multinational Enterprises (MNE) Three Ways MNE’s Diversify • Horizontal Integration • Parent company producing in source country establishes production of same goods in host country. Coca Cola Bottling Plants Cairo Beijing Paris Sydney Atlanta

5. Ch 10 – MNE’s Multinational Enterprises (MNE) Three Ways MNE’s Diversify • Conglomerate Integration • Ownership of subsidiaries in unrelated markets. • Example, General Motors purchases a diaper factory.

6. Ch 10 – MNE’s Multinational Enterprises (MNE) Foreign Direct Investment • The acquisition abroad of physical assets such as plant and equipment, with operating control residing in the parent corporation. • Acquiring controlling interest in an overseas company or facility. • Most US FDI goes to Canada and Europe. Four Ways: • Parent obtains enough stock in foreign company to have voting control. • Parent company acquires or builds plant or equipment overseas. • Parent company shifts funds overseas to finance expansion of foreign subsidiary. • Earnings of foreign subsidiary are reinvested for expansion.

7. Ch 10 – MNE’s Multinational Enterprises (MNE) Why Foreign Direct Investment? Demand Factors • Tapping into foreign markets and new sources of demand. Sometimes marketing division comes first, then manufacturing facility (if market is large enough). • Productive capacity is already enough to meet domestic demand. To grow faster than domestic demand, parent company has to export or establish production facilities overseas. • Combat market competition by foreign firms. May acquire existing companies (defensive move).

8. Ch 10 – MNE’s Multinational Enterprises (MNE) Why Foreign Direct Investment? Cost Factors • Supply advantages – acquire raw materials or locate in advantageous climates. • Labor costs – may be able to use cheaper foreign labor. • Transport costs – particularly when transport costs are a high fraction of product value. • Weight gaining industries will locate closer to final market (Coke, Pepsi) • Weight losing industries will locate closer to inputs (lumber, steel) • Government enticements – subsidies, tax breaks. • Avoidance of trade barriers.

9. Ch 10 – MNE’s Multinational Enterprises (MNE) Arguments Against FDI • “Inward flows of FDI bring bad jobs here, and outward flows of FDI send good jobs elsewhere.” This is a contradiction. In reality, foreign multinationals pay higher than average wages in US. • “US industries will leave US for low foreign wages.” Same argument we’ve seen before. Wages are linked to productivity.

10. Ch 10 – MNE’s Multinational Enterprises (MNE) Arguments Against FDI • “US foreign direct investment is investment that is NOT taking place here.” In many cases, the company would not have invested anything if it didn’t do so to expand into another nation. Also, much of FDI is reinvestment into existing foreign firm. Would not have been invested here. As traditional trade theory similarly suggests, FDI is NOT a zero sum game – both sides win.