International Economics

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.
In this chapter:
1. Introduction
2. Some Data on International Capital Flows
3. Motives for International Capital Flows
4. Welfare Effects of International Capital Flows
5. Multinational Corporations
1. 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
1. 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.
1. 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 or taking control of another firm.
 Table 12.1. US foreign Long-Term Private

International Investment Position, 1950-2008
 Table 12.2. U.S. Direct Investments Abroad by Area,
1950-2008
 Table 12.3. U.S. Foreign Long-Term Private
International Investment Position, 1950-2008.
 Figure 1. Trend of East Asia’s Net Portfolio Investment in
the U.S. 2002-2012 (US$ million)
Blue-China; Red- Japan; Green-EA developing countries

Source: Calculated by HHLEE using US Treasury Department’s TIC Database
 Figure 2. Trend of East Asia’s Net Equity Investment in
the U.S. 2002-2012 (US$ million)

 Figure 3. Trend of East Asia’s Net Long-term Security
Investment in the U.S. 2002-2012 (US$ million)

 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.
 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.
 Direct Foreign 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.

 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).
Vertical integration: offshoring
© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor


 Also done to avoid tariffs and other restrictions
that nations impose on imports, or to take
advantage of government subsidies
encouraging direct foreign investment.
Greenfield FDI vs. M&A
 Greenfield FDI:
 Set up a new company “from the ground up” in the
foreign country
 Examples:
 M&A:
 Buying shares of an enterprise in another country.
 Examples:
16
 Figure 4. Trend of FDI outflows from all OECD
countries, 2001-2011
Source: OECD International Direct Investment Statistics

Database
 Figure 5. Trend of M&A and Greenfied FDI outflows
from 20 OECD countries, 2001-2011
Reasons for rapid increase in FDI
 Flow and stock increased in the last 30 years.

 FDI has grown more rapidly than world trade
because:
 MNEs see the entire world as their market.
 Political and economic environment has changed in
favour of FDI in many countries.
 FDI is seen as a way of circumventing trade barriers
19
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
20
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
21
 Multinational corporations (MNCs) own, control,

or manage production and distribution facilities
in several countries.
 Today, MNCs account for about 25% of world
output, with intrafirm trade estimated at about
one third of total world trade in manufacturing.
 Most international direct investments are
undertaken by MNCs.
 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.
 MNCs can artificially change prices to only
show profits in low tax nations (transfer pricing).
 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.
 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.
5. 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.
 What is importance of international product

fragmentation?
 Reinforces the linkage between trade and FDI policies.
 Makes a strong case for the removal/harmonisation of non-border
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.
28
Figure 4: World trade in parts and components (P&C)
(Unit Billion US$)
25,000 100%
90%
20,000 80%
70%
15,000 60%
50%
10,000 40%
30%
5,000 20%
10%
0 0%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Manufactured trade Final goods Parts and components

Share of final goods Share of P&C
Source: Data calculated from UN Comtrade database

29
Figure 5: Share of parts and components trade of China
compared with the world average
40%
35%
30%
25%
20%
15%
10%
5%
0%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Share of P&C in import manufactured world trade Share of P&C in China's import manufactured trade
Share of P&C in China's export manufactured trade
Source: Data calculated from UN Comtrade database

30

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CHAPTER T W E L V E

International Resource Movements

 International trade and movement of

 Table 12.1. US foreign Long-Term Private

Blue-China; Red- Japan; Green-EA developing countries

Blue-China; Red- Japan; Green-EA developing countries

Blue-China; Red- Japan; Green-EA developing countries

Source: Calculated by HHLEE using US Treasury Department’s TIC Database

 International Portfolio Investments

 International Portfolio Investments

 Direct Foreign Investments

 Direct Foreign Investments

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

 Direct Foreign Investments

Source: OECD International Direct Investment Statistics

 Flow and stock increased in the last 30 years.

 Positive effects on Balance of Payment (BOP)

 Adverse effects on BOP

 Weakening of national sovereignty

 Multinational corporations (MNCs) own, control,

 Reasons for MNCs

 Problems in Home Country

 Problems in Host Country

 What is international product fragmentation?

 What is importance of international product

Manufactured trade Final goods Parts and components

Source: Data calculated from UN Comtrade database

Source: Data calculated from UN Comtrade database

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