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CHAPTER T W E L V E
12
International
Economics
Tenth Edition
International Resource Movements
and Multinational Corporations
Dominick Salvatore
John Wiley & Sons, Inc.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Learning Goals:
 Describe the motivation for international
portfolio and direct investments
 Describe the effects of portfolio investment on
investing and host country
 Understand the reasons for the existence of
multinational corporations and the effect on
home and host countries
 Understand the motives and effect of
international labor migrations (skip)
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Introduction
 International trade and movement of
productive resources are substitutes.
 As with trade, the movement of resources
between nations tends to equalize factor
returns.
 Two main types of foreign investments:


Portfolio investments
Direct investments
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Introduction
 Portfolio Investments





Purely financial assets, such as bonds or less
than 10% of voting stock, denominated in a
national currency.
Take place primarily through financial
institutions such as banks and investment
funds.
Equity investment vs. bond investment
Examples of equity investment:
Examples of bond investment:
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Introduction
 Direct Investments




Real investments in factories, capital goods,
land and inventories where both capital and
management are involved and the investor
retains control over use of invested capital.
Usually takes form of a firm starting a
subsidiary (greenfield investment) or taking
control of another firm through mergers or
acquisitions (cross-border M&A).
Examples of greenfield investment:
Examples of cross-border M&A:
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Some Data on International Capital Flows
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
2. Some Data on International Capital Flows
 Figure 1. Trend of East Asia’s Total Portfolio
Investment in the U.S. 2002-2011
1,800,000
1,600,000
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
2002
2003
2004
중국
2005
2006
일본
2007
2008
2009
동아시아 개도국
Blue-China; Red- Japan; Green-EA developing countries
Source: Calculated by HHLEE using US Treasury Department’s TIC Database
2010
2011
2. Some Data on International Capital Flows
 Figure 2. Trend of East Asia’s Equity Investment in
the U.S. 2002-2011
100,000
50,000
0
2002
2003
2004
2005
2006
2007
2008
2009
2010
-50,000
-100,000
-150,000
-200,000
-250,000
-300,000
-350,000
-400,000
중국
일본
동아시아 개도국
Blue-China; Red- Japan; Green-EA developing countries
Source: Calculated by HHLEE using US Treasury Department’s TIC Database
2011
2. Some Data on International Capital Flows
 Figure 3. Trend of East Asia’s Long-term Securities
(Bond) Investment in the U.S. 2002-2011
1,800,000
1,600,000
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
2002
2003
2004
중국
2005
2006
일본
2007
2008
2009
동아시아 개도국
Blue-China; Red- Japan; Green-EA developing countries
Source: Calculated by HHLEE using US Treasury Department’s TIC Database
2010
2011
Motives for International Capital Flows
 International Portfolio Investments
 The basic motive for international portfolio
investment is to earn higher returns abroad.

Portfolio theory tells us that by investing in
securities with yields that are inversely related
(like foreign and domestic securities) over time,
a given yield can be obtained at a smaller risk,
or a higher yield can be earned with the same
level of risk for the portfolio as a whole.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Motives for International Capital Flows
 International Portfolio Investments
 So a portfolio including both domestic and
foreign securities can have a higher average
yield and/or lower risk than one containing
only domestic securities.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Motives for International Capital Flows
 Foreign Direct Investments

The basic motive for direct foreign investment
is to earn higher returns (possibly from higher
growth rates abroad, more favorable tax
treatment or greater availability of
infrastructure) and to diversify risks.

Large corporations often have unique product
knowledge or managerial skill that could easily
and profitably be used abroad and over which
the corporation wants to retain direct control.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Motives for International Capital Flows
 Foreign Direct Investments

Horizontal integration is the production
abroad of a differentiated product that is also
produced at home.

Vertical integration (backward) allows a
corporation to obtain control of a needed raw
material and thus ensure uninterrupted supply
at lowest possible cost, or acquire later stages in
the production process, or ownership of sales or
distribution networks abroad (forward).
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Vertical integration: offshoring
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
Motives for International Capital Flows
 Foreign Direct Investments Also done to
avoid tariffs and other restrictions that nations
impose on imports, or to take advantage of
government subsidies encouraging direct
foreign investment.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
4. Welfare Effects of International
Capital Flows: Benefits of FDI

Resource Transfer


Stable source of foreign capital
Advanced technology
Advanced management skills

Creation of employment opportunities

True with greenfield FDI

Not so true with M&E

Stronger competition

Domestic market becomes more efficient with stronger competition among firms

Positive effects on Balance of Payment (BOP)

Capital inflow with initial FDI

When the goods/services produced by the FDI substitute for imported goods/services

When the goods/services produced by the FDI are exported to another country

Economic growth

To some extent, FDI may help the economy grow faster

16
4. Welfare Effects of International
Capital Flows: Costs of FDI

Adverse effects on competition

Foreign firms (MNEs) may have too much power and kill off competition

Adverse effects on BOP


After initial inflow of capital, subsequent outflow of capital from the
earnings of the FDI
Import inputs from abroad for the foreign firms

Weakening of national sovereignty

Possible loss of economic independence as some decisions that affect the
host country’s economy may be made by a foreign company that has no
real commitment to the host country
17
Multinational Corporations
 Multinational corporations (MNCs) own, control,
or manage production and distribution facilities
in several countries.
 Today, MNCs account for about 25% of world
output, with intra-firm trade estimated at about
one third of total world trade in manufacturing.
 Most international direct investments are
undertaken by MNCs.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Multinational Corporations
 Reasons for MNCs

Integration may increase profits through better
control of supply chains.

The larger scale of production may allow the
firm to better exploit economies of scale.

MNCs can better direct production to low cost
nations.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Multinational Corporations
 Problems in Home Country




Loss of domestic jobs to other countries.
MNCs may move technology out of the home
country reducing the technological advantage
of the home country.
Transfer pricing may reduce taxable income
and tax revenue.
Access to foreign markets allows MNCs to
circumvent domestic monetary and fiscal
policy control.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Multinational Corporations
 Problems in Host Country

MNCs are alleged to dominate their
economies.

R&D funds are siphoned off to the MNC’s
home nation, keeping host nation
technologically dependent.

MNCs may extract from host nations most of
the benefits of their investment, either through
tax and tariff benefits or tax avoidance.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Product Fragmentation and Foreign Outsourcing
 What is international product fragmentation?

The geographic separation of activities involved
in producing a good (or service) across two or
more countries’.

Alternative terms: vertical specialization, slicing
the value chain, international production sharing
outsourcing, or trade in intermediate goods.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Product Fragmentation and Foreign Outsourcing
Product Fragmentation and Foreign Outsourcing
 What is importance of international product
fragmentation?

Reinforces the linkage between trade and FDI policies.

Makes a strong case for the removal/harmonisation of nonborder policy barriers with a view to enhancing gains from
global integration

Has implications for the debate on regional versus
multilateral (global) economic integration approaches to
international trade policy.
24
1. Global value chain (GVC) – The concept
■ A value chain (VC) is a set of activities that a firm operating in a specific
industry performs in order to deliver a valuable product or service for the
market. (Wikipedia)
■ The concept comes from business management and was first described by
Michael Porter in his 1985 best-seller, Competitive Advantage: Creating and
Sustaining Superior Performance. (Wikipedia)
■ Global value chain (GVC) emerged in the late 1990s as multinational
enterprises (MNEs) or transnational corporations (TNCs) increased overseas
investment.
■ To enhance efficiency, MNEs locate “R&D, design, production of parts,
assembly, marketing" activities in different countries around the globe (i.e.
international fragmentation of production).
■ East Asia and Europe have been particularly at the center of GVC.
1. Global value chain (GVC) – The concept
■ Labour-intensive tasks such as assembly in GVCs take place primarily in developing
economies with abundant labour, while knowledge-intensive activities such as R&D and design
and marketing are concentrated in developed economies.
1. Global value chain (GVC) – The concept
1. Global value chain (GVC) – The concept
1. Global value chain (GVC) – The concept
2. GVC and trade in intermediate goods
■ Trade in GVCs involves extensive flows of intermediate goods
and services.
3. Conventional trade statistics and GVCs

How conventional trade statistics is calculated
 Total value of all (final and intermediate) goods passing through customs

Problems with conventional trade statistics
 It is exaggerated because of double counting.
 When a country exports, only domestic value-added contributes to GDP.

A new measure: Trade in Value Added (TiVA)
 In May 2013, the OECD and the WTO released its first version of Trade in
Value Added (TiVA) database, integrating national input-output tables with
trade data.
 It includes “decomposition of gross exports by industry into their domestic
and foreign content”, “bilateral trade balances based on flows of value added
embodied in domestic final demand”, etc.
3. Conventional trade statistics and GVCs
■ Global value added in trade
4. An Anatomy of GVCs using TiVA
■ Domestic valued added content of gross exports, %
Source: OECD-WTO TiVA database
5. Reasons for Fast Expansion of GVCs
■ GVC Participation rate is higher in countries with more FDI
stock.