Ib Lecture 1

Front 1

How to become a MNE?

Back 1

Firms becomemultinationalenterprises(MNEs) byundertakingforeign directinvestment (FDI)in multiplecountries

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FDI

Back 2

investmentin controllingand managingvalue-addedactivities in othercountries; differsfrom foreignportfolioinvestment

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FDI flows

Back 3

amount of FDIover certainperiod of time

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FDI stocks

Back 4

accumulatedvalue of foreignassets

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Foreignsubsidiary

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AnMNE unit locatedin a foreigncountry, called a‘host country’

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Globalization

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A process leading to greater interdependence andmutual awareness among economic, political, andsocial units in the world, and among actors in general

comes in waves

Innovations intransport and ICT

Trade liberalization

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Globalization 1.0

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Technological changes

Trade liberalization

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Globalization 2.0

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MNEs

Trade liberalization (e.g., GATT)

Raise of Emerging Economies

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FDI inflows

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Flows to developed economiesnearly doubled (up 84 per cent)rising from $522 billion in 2014to $962 billion

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FDI outflows

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Investments by MNEs from developedeconomies surged. Europe became theworld’s largest investing region.

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Trade costs

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Intra-regional trade is generallyless costly than extra-regionaltrade

Group of developing countriesthat is known to have very hightrade costs is the landlockedcountries.

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Absolute advantage

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ability of one country to produce acommodity more efficiently (i.e. with greater output per unit ofinput) than another country.

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Comparative advantage

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advantage in the production of aproduct enjoyed by country A over country B when thatproduct can be produced at a lower opportunity cost in countryA than it could be in the country B

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law of comparative advantage

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nation shouldspecialize in producing and exporting those commodities which itcan produce at a relatively lower (opportunity) cost, and that itshould import those goods for which it is a relatively high-costproduce.

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Global Connectedness Index (GCI)

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Global connectedness refers to thedepth and breadth of a country’sintegration with the rest of theworld, as manifested by itsparticipation in international flowsof products and services, capital,information, and people.”

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Globalization advantages

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Local producers can sell theirproducts in distant markets withthe same ease and speed as intheir home country

Money flows easily across localand national boundaries

Easy access to external capital(credit) and rising leverage

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Globalization disadvantages

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New risks and uncertaintiesbrought about by the high degreeof integration of domestic andlocal markets (unstable andunpredictable demand and theirproducts quickly becomecommodities, leaving them little orno pricing power)

Intensification of competition

High degree of imitation

Price and profit swings Businessand product destruction

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TTIP positive

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Regulatory compatibility and coordination:At the moment, many EU and U.S. standardsare comparable but not mutually recognized.This leads to increased costs; e.g., manyproducts have to go through safety teststwice in order to be certified in both regions.Better compatibility would lead to hugesavings and an increase in trade.

Cheaper products and more choice forconsumers: TTIP will abolish import tariffsand other barriers to trade. This means thatproducts from the US can be imported intothe EU more cheaply.

GDP growth

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TTIP negative

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Downward harmonization: Adapting tradelaws such as labor laws, industry standards,or quality control “downward” to the tradelaws of the U.S.

Extending the scope and power of investorstatedispute settlement (ISDS) system(enabling firms to sue governments);

Adverse economic impact (loss of jobs); onlythe expected efficiency gains due toproductivity growth will provide for positiveresults in the longer term

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WHY DO SOME FIRMS GO GLOBAL?

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globalization can beachieved because oflow transactioncosts, associatedwith deploying andexploiting nonlocationbound firmspecificadvantagesin distant markets

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Where do MNEs derive their sales?

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MNEs derive the majority of their sales in their homeregion.

The world’s largest firms are not global but regionallybased, in terms of breadth and depth of market coverage

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Liability ofoutsidership

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all additional costs a firm operatingin a market overseas incurs that a local firm would not incur

distant origins

lack of local experience

lack of nearby experience

(familiarity, networks and legitimacy in local context)

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distant origins

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costs directly associated with spatial distance, such as the costs of travel,transportation, and coordination over distance and across time zones;

b) costs resulting from the host country environment, such as the lack oflegitimacy of foreign firms and economic nationalism;

c) costs from the home country environment, such as the restrictions onhigh-technology sales to certain countries imposed on U.S.-owned MNEs

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WHY DOES LIABILITY OF OUSTIDERSHIP MATTER?

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foreign firm notbeing sufficiently embedded in theinformation networks in the hostcountry

information disadvantage is thecost that a foreign firm in this industry islikely to bear compared to a local firm

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OLIparadigm

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ownership(O), locational (L), andinternalization (I) advantagescombine to induce firms toengage in FDI

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OWNERSHIP ADVANTAGE

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internal firm-specific capabilitythat is transferable across borders

resources created in one country can be exploited in other countries

sharing of resources

combining business units across boarders

capabilities arising from corporate culture and structure

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LOCATION ADVANTAGE

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May relate to thelocal market, localresources (naturalresources), localagglomerations(knowledgespillovers, specializedlabor, and ecosystem),and localinstitutions (freeaccess to markets vs.barriers to foreigninvestors), etc

Protectionism

Transportationcosts

Direct interactionwith customers

Production andsale of someservices Marketing access

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market failure

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imperfections of the marketmechanism that make some transactionsprohibitively costly (such as the risk ofopportunistic behavior by exchange partners)

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INTERNALIZATION ADVANTAGE

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Exists if market exchange comes with hightransaction costs

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Vertical FDI preferred overexporting if one party needs tomake an investment with highasset specificity:

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an investment that is specific to abusiness relationship (assetspecificity: an investment that isspecific to a business relationship;that is, the extent to which the valueof an asset is lost when it is utilizedoutside of a certain context)• results in high “sunk costs”• example: aluminum industry

Front 31

FDI preferred over licensing if

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dissemination risk is high

knowledge is tacit (noncodifiable)

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Asset specificity

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Physical assetspecificity

Equipment andmachinery thatproduce inputsspecific to aparticularcustomer or arespecialized touse an input ofa particularsupplier.

Site specificity

Site specificityoccurs wheninvestments inproductive assetsare made in closephysical proximityto each other.Geographicalproximity of assetsfor different stagesof productionreduces inventory,transportation, andsometimesprocessing costs.

Human assetspecificity

Human-assetspecificityrefers to theaccumulationof knowledgeand expertisethat is specificto one tradingpartner.

Dedicated assets

Dedicated assets byan input supplierare investments ingeneral capital tomeet the demandof a specific buyer.The assets are notspecific to thebuyer, except that ifthe specificcustomer decidednot to purchase, theinput supplierwould havesubstantial excesscapacity.

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THE HOLD-UP PROBLEM

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The hold-up problemresults from situationswhere it is difficult towrite completecontracts. When oneparty has made a priorcommitment to arelationship withanother party, thelatter can ‘hold up’ theformer for the value ofthat commitment.

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KEY TAKEAWAYS

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1) Globalization comes in waves

2) Firms need to overcome “liablity ofoutsidership” when expandingabroad– Ownership advantages helpfirms to do so

3) Firms select host countries basedon location advantages

4) Firms internalize only if these are“cheaper” than market transactions