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MGT 4230 - EXAM 2 (chapters 6-9) (Chapter 6: TRADE THEORY)IntroductionInternational Trade Theory:explains why it is beneficial for countries to engage in international tradehelps countries formulate their economic policyexplains the pattern of international trade in the world economy TradeFree trade: refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country Absence of any government in tradeFree trade to economists is like zero gravity to physicists Probably no country that has ever been completely freeIt’s the most efficient way to allocate scarce resourcesThis differs from “fair trade” or “managed trade”Fair Trade: (a hot topic in regards to China)Managed Trade: assumes a government’s role but the government helps its firmsIdea with trade exports & importsTrade Deficit: when what a country imports from other countries is greater than what a country exports to other countriesBuys > Sells OR Imports > ExportsLargest trade deficit = U.S.In 2016: -$502 billion deficitIf our dollar is strong, it makes the foreign things we buy cheaper and our things more expensiveIn 2017: -$566 billion deficit (largest since the great recession in 2008)(with China & Mexico)The last year U.S. had a trade surplus was 1975Trade Surplus: when what a country exports to other countries is greater than what a country imports from other countriesSells > Buys OR Exports > ImportsCountries doing well with trade surplus: Japan, Iran, South Korea, Germany(German wage rates are the highest in the world. They specialize in more sophisticated, high technology)Saudi Arabia imports oil (in Louisiana)Germany imports for BMW (in S.C.)U.S. Trade: Exports…1. Canada2. Mexico3. China4. Japan5. UK6. Germany7. S. Korea8. Netherlands9. Brazil10. Hong Kong11. Belgium12. France13. Singapore14. Australia15. TaiwanGeneral similarity among 13 of these countries…DemocraciesDeveloped countries(Brazil & China aren’t but they are developing)U.S. Trade: Export Products…1. Machinery, nuclear reactors, boilers, etc.2. Electrical, electronic equipment3. Mineral fuels, oils, distillation products, etc.4. Vehicles other than railway, tramway5. Aircraft, spacecraft, and parts thereof6. Optical, photo, technical, medical, etc. apparatus7. Pearls, precious stones, metals, coins, etc.8. Plastics and articles thereof9. Organic chemicals10. Commodities not elsewhere specified11. Pharmaceutical products12. Miscellaneous chemical products13. Oil seed, oleagic fruits, grain, seed, fruit, etc.14. Articles of iron or steel15. CerealsU.S. Trade: Imports…1. China2. Canada3. Mexico4. Japan5. Germany6. South Korea7. UK8. Saudi Arabia9. France10. India11. Italy12. Taiwan13. Ireland14. Venezuela15. SwitzerlandU.S. Trade: Import Products…1. Mineral fuels, oils, distillation products, etc.2. Machinery, nuclear reactors, boilers, etc.3. Electrical, electronic equipment4. Vehicles other than railway, tramway5. Optical, photo, technical, medical, etc. apparatus6. Commodities not elsewhere specified7. Pearls, precious stones, metals, coins, etc8. Pharmaceutical products9. Organic chemicals10. Furniture, lighting, signs, prefabricated buildings11. Plastics and articles thereof12. Articles of apparel, accessories, knit or crochet13. Articles of apparel, accessories, not knit or crochet14. Articles of iron or steel15. Aircraft, spacecraft, and parts thereofU.S. has a lot of the categories that we both sell & buy (same products or overlap)Trade theories are either country-based or firm-based…Country-Based Theories: Mercantilism, 1.)Absolute Advantage, 2.)Comparative Advantage, 3.)Relative Factor Endowments, 4.)Linder’s Overlapping Product Ranges, & 5.)International Product Life CycleFirm-Based Theories: 1.)New Trade Theory, 2.)Diamond Model, & 3.)Rugman VerbekeCountry-Based Theories… All country-based theories (excluding mercantilism) are also cost-based***Mercantilism:Not really a theory. More of a philosophy or theologyProsperity measured by holdings of bouillonMaximize exports; minimize imports through trade barriersBasis for current protectionist sentiments The most anti-free trade policyGovernment is VERY involvedClassical Theories of Trade…1.) Absolute Advantage:Developed by Adam SmithCountries should specializeAbsolute advantage are the roots of modern economic thinkingFocused on exporting products in which the country is more productive(Focus on products with absolute advantage)Idea: What can we produce MORE of?What if the country has an absolute advantage in both products?2.) Comparative Advantage:Developed by David RicardoFocus on products in which the country has a relative advantageIn order to comparative advantage, there is always an opportunity to tradeWithout trade, each country must consume what it producesBy engaging in trade, two countries can increase their combined production of their specialized products, and consumers in both nations can consume more of both goodsIncorporates opportunity cost & production possibilities(When a country produces a good or services for a lower opportunity cost that other countries)Problem…It doesn’t address sources of advantageit doesn’t completely explain why some companies do well and others don’tEx: Guns vs. Butter Model…First curve= Production Possibility Curve…Represents all combinations of guns and butter that a country can produceSecond curve= Consumption Possibility Curve…Represents opportunity costs of what has to be given up to produce either of the 2 (guns or butter)Y-axis= Guns…Use all of the country’s resources to produce gunsX-axis= Butter…Use all of country’s resources to produce butter3.) Relative Factor Endowments:Developed by Heckscher & OhlinBased on two propositions…1. Country factor endowments vary2. Different goods require different factorsFocus on producing goods that use abundant factors most intensivelyA country should focus on products that use their resources best & export or import products for which they don’t have resources for***U.S. exports capital intensive productsU.S. imports labor intensive productsWas not supported by Leontieff (Leontieff Paradox)(U.S. was importing capital intensive products & exporting labor intensive products)4.) Linder’s Overlapping Product Ranges:Based on demand for manufactured goodsIncome determines product sophisticationTrade occurs between countries of similar income levels5.) International Product Life Cycle:Developed by VernonInternational product life cycle has three phases…1. New product (mostly domestic or at home)2. Mature product (export oriented)3. Standardized product (import emphasis)1st section= Phase I: Innovationnew product (mostly domestic)2nd & 3rd section= Phase II: Rapid Growth/Salesmature product (export oriented)4th section= Phase III: Product Dies Downstandardized product (import emphasis)(There are no TVs in America today that were made in the U.S.)Problem…If product starts at home, it’s not always going to be just at home during phase 1Summary of Country-Based TheoriesCountry focus does not explain intra-industry tradeCountry focus does not explain the relative success of firms within a countryAs a result, firm-based theories have been developed(As we see the deficiencies of county-based theories, we shift towards firm-based theories)***Firm-Based Theories…1.) New Trade Theory: Rivalry:(The only pure firm-based theory)Based on strategy of firm & competitive advantageFocuses on intra-industry trade and firm strategyCompetitive advantages in the marketplace explain tradeSources of competitive advantage include: first mover advantages, R&D, intellectual property, economies of scope & scale, experience2.) The Diamond Model:Developed by Porter(Competitive advantage in the home country: If a firm comes out of this model in the home country, they will be more successful in competing)2833227856615INNOVATION00INNOVATIONCompetitive advantage is determined by the interplay of…Factor Conditions: Deals with the quality and abundance of resources Large labor force? Skills? Sophisticated financial markets?Plant? Equipment?(land, labor, and capital)Demand Conditions:Market base= consumersHow sophisticated are the consumers?Do consumers have high expectations? Are they being met?Do they have good purchasing power?Related & Supporting Industries:Deals with inputsInfrastructure, communicationFirm Strategy, Structure, & Rivalry:Deals with the degree of competitionHigh rivalry fine tune the strategy and organizations structureInnovation:Innovation is key***innovation drives a businessChance and government play a role:Resource based and refinement government plays a huge role in theseThere are anti-trust laws to ensure rivalry(these boxes in the model drive the firm to do new things (innovation))3.) Rugman-Verbeke:Two types of advantages…1. Firm specific (caliber of labor, quality of products, marketing, distribution, production, etc.)if firm does well, it contributes to firm’s performance2. Country specific (economic, government, etc.)government policy with regard to taxes, investments, etc.The most effective MNC strategies are based on linking the advantages and adjustmentTrade and PolicyWhile the theories all suggest that trade is beneficial, they lack agreement for government policy… Mercantilism makes a case for government involvement in promoting exports and limiting importsMercantilism is most anti-free trade policy (government is VERY involved) Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade(most economist’s perfect scenario: unrestricted free trade) New trade theory and Porter justify limited and selective government intervention to support the development of certain export-oriented industries“companies that have potential” assist the company in order to stimulate its growthImproving Trade PositionsSeek to open foreign marketsGovernment’s responsibility seek to opening foreign marketsManagers must develop a global orientationManager’s responsibility global outlookFocus on competitive advantage factors: labor costs, interest rates, exchange rates, economies of scale, productivity, infrastructure, & innovationBoth Government’s & Manager’s responsibilitiesImplications for Managers…1.) Location Economies: disperse productive activities to those countries where activities can be performed most efficientlywant cheaper labor costs and most efficiencyNetwork affiliated2.) First-Mover: establishing a first-mover advantage in the production of a new product may later dominate global trade in that productEngage in research and development, translate that into products, & market and distribute products effectively (Chapter 7: TRADE POLICY)EU-US and Beef1989 - EU bans growth hormone treated beefU.S. exports declineU.S. files complaint to WTO (files with other countries)1998 – U.S. wins WTO Panel declares EU ban to be illegalEU is appeals (reluctant to comply)EU loses the appeal1999 – U.S. raises tariffs on EU products (U.S. raises tariffs in retaliation)U.S. Targets EU by raising tariffs specifically on…BeefPorkSausagesCorned BeefRoquefort CheeseChocolate ProductsMustardsChewing GumSoups and BrothsTrufflesMineral WaterCut FlowersYarnElectric Hair ClippersMotorcycles and MopedsThis retaliation was designed to spread the hurt and hit a wide array of European countries (different products affected different countries in the EUEx: yarnUK, sausagesGermany, etc.Issues…Subsidies in agriculture (MAJOR ISSUE)U.S. subsidizes agriculture heavily(agriculture is always at the forefront of trade disputes)Intellectual property rightsAlso at forefront in trade discussions(Free trade is the most efficient way to allocate scarce resources)Questions of Trade…***Should government protect domestic firms at home?Should government assist domestic firms abroad?Hard power: use of military force, coercion, and intimidation of a country to influence others to do what is wanted Mostly military Can be economics in the sense that…Economics can coerce countries with sanctionsSoft power: ability of a country to persuade others to do what is wanted without force or coercion Economics can “woo” a country with wealthPolitical Arguments for Intervention…(talking about when the government intervenes in the market)Protecting jobs and industries:Need to protect jobs in U.S. from cheap foreign laborCheaper labor is a basis for a competitive advantage Economists have the most trouble with this idea. (cheap foreign labor argument) (completely contradictive to idea of free markets)Need to restrict tradeNational security:Defense industries (most obvious) – semiconductorsEx: don’t want to rely on foreign companies to make military weaponsRetaliation:We raised tariffs on Chinese products, they respondedEx: currently with the Chinese with the Trump AdministrationProtecting consumers:Safety issues with consumersEx: we have many restrictions on foreign pharmaceuticals entering the U.S.Furthering foreign policy objectives:Helms-Burton Act(Cuba specifically)Try to get change in government, deter nuclear development, etc.Protecting human rights:(Self-explanatory)Cheap Foreign Labor: market’s resources are distributed differently and specialize according to comparative advantageBest way for trade when countries trade their products with a comparative advantageEconomic Arguments for Intervention…(talking about when the government intervenes in the market)(because it is economic, doesn’t mean economists are always on board with it)Infant industry:Oldest argument - Alexander Hamilton, 1792Protect yourself (tariffs, quotas, etc.)How can a fledgling country (like U.S.) & it’s companies compete among its world powers?Protected under the WTOOnly good if it makes the industry efficient and makes its firms better(it typically doesn’t do this) Brazil auto-makers - 10th largest - wilted when protection petition was the driver in their innovation and when their protection was eliminated, (their barriers that they erected were removed) development was stagnated. Other auto-making companies grew and Brazil auto-makers could no longer competeRequires government financial assistance(Indirect or direct)If these companies (new or old) are a good investment, global capital markets would investThe markets are more likely to pick the “race horses”, government can pick the “mules”(markets will always be better at picking winners than the government)***Markets are better at assessing risk, make judgements about companies, etc.Just need to give the companies a good startPrinciple concern: it doesn’t work most of the time in terms of helping those new firms in new industriesOld industries can use infant industry policiesIssue: When does the industry grow up?Strategic trade policy:(based upon new trade theory)Government helps raise national income if first-mover advantage is successfulGovernment intervention may help domestic firms overcome first-mover advantage of foreign firmsHelp the firm catch upEx: Solar Energy. Although technology of it was pioneered in U.S., we have fallen behind. (if other countries halted, it would take America 5 years to catch up) Say maybe, we need to protect the solar companies in the U.S. to make up for lost time compared to Japanese and Chinese (who are farther ahead of us).^^These above bullets are high impact (Anything that is spent, will return in pay-off over time, with success)We are talking about an industrial policy (mostly done with subsidies, but can be done in other ways…tax breaks, etc.)Japan and others make decisions based off of MITI (Ministry of International Trade and Industry)Corporate Welfare: U.S. make decisions based on political favoritism (lobbying campaigns) instead of based on the market (market logic)Argument: If we are going to do it, we might as well be honest, do it strategically, and be straightforwardQuestions About Trade Policy…1.) Should we assist our companies in global markets to make them more competitive? 2.) How can a fledgling country (like the U.S.) & it’s companies compete among its world powers?Instruments of Trade Policy…1.) Tariffs:Tariff: a tax on an imported goodThe oldest form of trade policyTariffs can take 2 forms… (specific or ad valorem)Specific Tariff: a set amountCar ex: tariff $2,000 per car being imported from GermanyIssue: tariff is the same amount no matter the price of car. Same tariff amount ($2,000) whether it’s a $20,000 car imported or a $120,000 car imported.(unequal impact depending on what the value is)Ad Valorem Tariff: pay taxes based on the value of the productex: property taxes in the U.S., tariff U.S. has on steel, etc.Car ex: tariff is 3% of the value of your carmore expensive car will have higher tariff$120,000 imported car has a higher tariff than $20,000 imported carCompound tariff: both specific & ad valorem forms of tariffsCar ex: $2,000 (specific tariff) + 3% of the value of your car (ad valorem tariff)Good for the governmentTariff $$ goes towards U.S. governmentGood for domestic producers (makes consumers buy domestic products rather than foreign)But reduces efficiencyLess incentive to keep prices down because competitors are more expensiveBad for consumersPaying more for foreign AND domestic productsEx: They make German cars and American cars more expensive in the U.S. (because of less incentive to keep prices down since competitors are more expensive)Can influence investmentInvestment directly influences job creationDirect impact on jobs***“Tariff Effects on SC” Article:“Trade dispute we have with China could go on for 20 years”Key: We export a lot from S.C. to Mexico and Canada. Represents $6.2 billion of the S.C. economy. We (S.C.) are most susceptible to trade wars. 1 of the top 10 states that would be adversely effected if NAFTA were to implode.With NAFTA we have more access to Mexican markets. It has been helpful with all parties because it allowed us to become more competitive at a time where other countries like China could have disrupted.If NAFTA implodes…small firms would be hit. 8 out of 10 firms who export from S.C. are small firmsBMWIn mexico in greer: an investment of 8 billion$3 major investments, including initial investment, that has expanded the capacity at BMWWhat do you do?Invest in educationIt’s not just about the cost for consumers. With investment, there can be a direct impact on jobsAntidumping Policies:Dumping: Either selling goods in a foreign market at below production costs or below fair market valueDumping results in either excess production or predatory behaviorPredatory behavior: sacrifice profits today in order to gain a major market share to pay it off in the futureWe have antitrust laws that make predatory pricing illegal in the U.S.Remedy seek imposition of tariffs (countervailing duties)Countervailing duties: offset the amount below fair market value (FMV)Ex: say foreign companies were exporting steel into the U.S. at below fair market value (dumping). U.S.’s duty would then be to add a 30% tariff to the steel to make companies more competitive.A special kind of tariff for a specific situation(When you hear about trade policies…they are either tariff or non-tariff barriers)2.) Non-Tariff Barriers:(quotas or administrative policies)Quotas: a quantity restriction on an import (imposed or voluntary)Ex: Japanese Trade Carriers… Imposed Restriction: “U.S. says Japan can send 900 cars at any point during the year and that is it”Voluntary Restriction: “If the Japanese are offered a restriction on exports (900 cars), they could offer a better deal than whatever the U.S. would impose”(if you volunteer, you might get better terms)Quotas benefit domestic producers by limiting import competitionCost to consumers ($1 billion/year in 1981–1985 for Japanese cars).It restricts supply which causes prices to increase (all other variables stay the same)Consequences: high prices for consumers for the foreign good and the American good (same consequences as tariffs)Administrative Policies: bureaucratic rules designed to make it difficult for imports to enter a countryOften are intentional but don’t have to be (Can just be one’s way of doing business)Some examples… local content requirements may try and keep you out because local producers might be worse licensing permitsstandards like quality, purity, safety, etc.regulations(that restrict access to the market)Can be difficult to identify, address, and determine what the effects areMore of a problem than the other trade effectors HUGE problem in Africa***“We talked about an array of administrative policies that can affect trade. These issues are evident in the following video about trade among some African countries.”.) Subsidies:Subsidy: a payment (assistance) to a domestic producer (doesn’t necessarily have to be cash)Cash grantslow-interest loans (lower than market interest rates)tax breaksgovernment participation of the equity in the companyEx: Airbus vs. Boeing…Airbus is a consortium. French, German, and UK governments all own a part of itBoeing can’t compete with 3 governmentsU.S. subsidizes Boeing Who pays for subsidies?Subsidies are generated from taxesTaxes are paid by tax payers… Tax payers pay the government…The government pays for subsidiesAnnual Cost to American Consumers for Import Protectiongreen: the amount of extra money that American consumers have paid. (Majority goes towards producers)Retaliation…Helms-Burton Act:Passed in 1996Allows Americans to sue foreign firms that use property in Cuba that was confiscated from them after the 1959 revolutionBacklash from Canada and Europe…(you can’t tell us what our firms can or can’t do in Cuba)Violates a state’s sovereignty (our sovereignty rights were violated)Still on the books, but has never really been enforced(not expected to know this because it hasn’t been enforced)General Agreement on Tariffs and Trade (GATT)*** WWII allies want international organization in trade arena similar to UN in political arenaIdea: If the countries had economic relationships, they’d be less likely to have a war(After WWII, main priority is keeping WWIII from happening)GATT proposed by US in 1947 as a step toward an international trade organizationGoal: set up organization to facilitate tradeGATT had 19 original membersIdea of multilateral agreementGoal: to reduce tariffs and facilitate tradeHow does it facilitate trade?Multilateral Agreement: objective is to liberalize trade by eliminating tariffs, subsidies, import quotas, etc. using “Most Favored Nation” status“Most Favored Nation” status:Most of the developed nations have this statusAn agreement with 2 most favored nations applies to all other most favored nationsEx: Italy and US (2 most favored nations) strike a negotiation. The negotiation would then apply to all other most favored nationsMuch more efficient than bilateral. It involves all countries, reducing costs and timeUsed “rounds” to gradually reduce trade barriersProducts of developing countries are sometimes given duty free access to developed onesGATT Negotiating Rounds…Geneva 1947 233594100254000Annecy 1949 13Torquay 1950-51 38 Geneva 1956 26Dillon 1960-62 45Kennedy 1964-67 62Tokyo 1973-79 99Uruguay 1986-94 117Doha? Doha Discussions started a while ago. Big divide between what the developed countries want and what the developing countries want(India not happy about the Doha rounds at the moment)Uruguay much longer round than others and had much more participating countriesWorld trade and world income have increasedAverage Reduction in US Tariff Rates 1947–1985very high tariff rates on average coming into the U.S. pre-GenevaImpact of GATT…Currently, >120 membersRepresents 90% of world trade9 of 10 disputes satisfactorily settleddid a good job at settling trade disputesTariff reduction from 40% to 5%Trade volume of manufactured goods has increased 20 timesUruguay Round (1986-1984)Most comprehensive trade agreement in history (to that date)Created the World Trade Organization (WTO)(During this round…GATT mutated into the WTO)***Impacted:Agriculture subsidies (stumbling block: U.S./EU)Applied GATT rules for goods to services and intellectual property issuesFirst time addressing services and intellectual property issuesStrengthened GATT monitoring and enforcement of trade agreementsLeading Exporters of ServicesU.S. is largest exporter of servicesGATT Criticisms…Economic theories don’t fit the “real world” modelThey don’t really address the underdeveloped countries’ needsU.S. global superiority has declined“Same time as tariffs decreasing, so GATT must be reason for decline”American percentage of the global markets declinedmost of that decline was natural; some due to increased globalization, some due to more competition from countries, some due to Japan’s technological advances (the playing field is more level)this shows up recently in the presidential election…Clinton signed NAFTA into law. Was started by Bush“Global Elites”, “America First“saw more of an isolationist sort of discussion across the political parties. That manifests in some of Trump’s decisionsShift from cutting tariffs to eliminating non-tariff barriers angered countries & created some resentment“National Treatment” or “Most Favored Nation” status results in inequalitiesdeveloped vs. developing nationshas led to disputes between these nationsWorld Trade Organization (WTO)***(GATT mutated into WTO after Uruguay round)Umbrella organization for GATTMission: “ensure that trade flows as smoothly, predictably, and freely as possible”Job # 1: Facilitate tradeJob # 2: Arbitrate disputesResponsibility for trade arbitration:Reports adopted unless specifically rejectedAfter appeal, failing to comply can result in compensation to injured country or trade sanctionsEx: U.S. with beef disputeWTO -World Policeman?104 disputes brought to WTO in first three years (196 in 50 years of GATT)Probably the case: WTO is a better mechanism for resolving trade disputesU.S.: 108 cases as complainant (we’ve filed the complaint); 124 as respondent (we’ve had the complaint filed against us). Big wins: beef & bananas Big loss: Kodak (Kodak filed suit against Fuji for film and what they considered unfair trade practices. Lost the suit and the appeal)Overall, financial services (one of the biggest service exports) and telecommunications have been big winnersPORTER’S GUIDELINES FOR GOVERNMENT POLICIES…Focus on specialized factor creationResources=factors“improve education”Incentive capital formation (tax breaks, etc.) for higher productivity Avoid intervening in factor & currency marketsDon’t intervene in resource marketsPorter doesn’t like messing with capital marketsUK doesn’t even have a minimum wage Enforce strict product, safety, & environmental standardsPorter likes intervention in this case: you’re going to have to meet product, safety, and environmental standards anyways, and all of these are good for sustainabilityLimit direct cooperation among industry rivalsPorter believes cooperation reduces rivalry. Not a good thing.Doesn’t like strategic cooperation between direct rivals (ex: Toyota & BMW) Promote sustained investment Deregulate competition Enforce strong domestic antitrust policiesanything that interferes with competition…Porter doesn’t favormakes sense with diamond model Reject managed tradePorter doesn’t like governments making decisions that should be made in the market place(“Markets should make decisions with trade. Not governments”)“Facilitating the climate for doing business”^^ graph of U.S. business environment compared to other developed countries (ex: Australia, Japan, Western Europe, etc.)upper right (green): all about innovation, capitalizing on innovation, etc.lower right (orange):lower left (red): tax code has kind of improved since this graph was made. We have addressed some regulation. Main thing=political system and has gotten worse. (winner take all idea. Republicans vs. democrats. Merely two divided parties that don’t work together well. Need to remember: We are Americans first. Democrats or republicans second(Chapter 8: INVESTMENT)International InvestmentInvestment is kind of the sister of tradeTrade and investment may be complements or substitutesEx: South Africa…Substitutes: (of trade) you are exporting to South Africa and they decide to raise tariffs. Afraid not competitive so you establish manufacturing in South Africa and no longer exportComplements: if you use manufacturing in South Africa to trade to other neighboring African countriesTwo types of investment…1. Portfolio Investment:mostly about people or individualscontrol of the foreign assets is < 10%2. Foreign Direct Investment (FDI):mostly about countries or companiescontrol of the foreign assets is > 10%more common type of investmentmost important for the MNCsinvestment is decreasing at somewhat the same rate as trade hasControl is the major issueThe difference is control of the foreign assetsMagic number = 10%If less than 10% of control on foreign assets= portfolio investmentIf more than 10% of control on foreign assets= FDI(Currency value and political risk play heavily in this)Foreign Direct Investment (FDI)(We are mostly talking about the globalization of production. Investing to producing markets in foreign countries instead of exporting to them)FDI is a primary means of going international, one that allows the MNC to avoid trade barriersTwo basic strategies of FDI (acquisition vs. greenfield)Ex: want boots on ground. You either…Acquisition: acquiring an existing companyAdvantages buy competitive advantages of the firm (helps you compete when bought), and speed (as soon as the deal is signed, you have profits)Disadvantages expensive (paying a premium of the company or a ‘goodwill’ according to accountants), integration, “brown field” (buy a company knowing it’s not up to competitive standards. Have to pour cash in it to make it “green”)ex: go to Japan and buy a Japanese companyGreenfield: create company in another countryadvantages it’s cheaper, complete control from day 1disadvantages slower process, market penetration issues (liability of being foreign)ex: go to Japan and create a companySome companies use a mix of the strategies (ex: Starbucks)Foreign Direct Investment (FDI)FDI is explained by demand, supply, and governmental factors… Demand factors: customer access & mobility, protecting intellectual propertySupply Factors: logistics (transportation costs, perishability, etc.), resource availability (cheaper labor, lower taxes, etc.), technology access, & production costsPolitical Factors: trade barriers (incentivizes FDI) & development incentives (offering incentives to foreign companies)Theories of FDI…Ownership Advantage Theory: FDI occurs when firm advantages can be transferred to foreign marketsIdea: FDI is going to occur if the company can transfer competitive advantages to host countryInternalization Theory: when transaction costs are high, FDI will occurInternalize it or externalize it?External: have transaction costs (ex: monitoring contracts, negotiating contracts, transportation, etc.)Which is better/less costly? FDI or contracting to foreign companies?Eclectic Theory: combination that suggests FDI occurs when there are advantages from location, ownership, or internalizationgoing to happen when location economies realize (cheaper labor, lower taxes), and if there are lower costs, to do it yourselfU.S. has been a proponent of FDI for a while. Trump administration not as much a fan of completely open FDI wants to bring manufacturing back to the U.S. (tax rates to incentivize to bring back U.S. company manufacturing)Sources of FDI into U.S….1. Netherlands2. France3. United Kingdom4. Japan5. Canada6. Belgium7. Cayman Islands8. Luxembourg9. S. Korea10. Hungary11. Germany12. Mexico13. Sweden14. Singapore15. ItalyFDI into U.S. by Industry…1. Manufacturing2. Trade and repairs3. Mining and quarrying4. Electricity, gas and water5. Other services6. Construction7. Hotels and restaurants8. Financial intermediation9. Agriculture and fishing10. Real estate, renting and business activities11. Transport, storage and communicationDestinations of U.S. FDI…1. Netherlands2. United Kingdom3. Luxembourg4. Bermuda5. Canada6. Cayman Islands7. Ireland8. Australia9. Switzerland10. Singapore11. Mexico12. Brazil13. Germany14. Norway15. ChileFDI from U.S. by Industry1. Real estate, renting and business activities2. Manufacturing3. Trade and repairs4. Mining and quarrying5. Financial intermediation6. Other services7. Transports, storage and communication8. Hotels and restaurants9. Electricity, gas and water10. Construction11. Agriculture and fishingTrends in FDI…Developed DevelopedDeveloped DevelopingDeveloping Developed(India will probably take over for the # 1 FDI destination (instead of China) because of things like democratic government, English widely spoken, cheap labor, lower levels of corruption, good large ports, possible trade war with China, etc.)U.S. FDI PositionHost Country FDI Benefits…Creates demand for exports & jobsIncreased technology & knowledgeKnowledge: management skills, knowledge of the industry, manufacturing process, etc.Lower consumer pricesIncreased productivityKnowledge and technology could increase productivityProduct & process innovationEconomic growthHost Country FDI Problems…Can drive out local competitorsCan prevent development of local competitorsCan be a deterrentProfits may go “home”(repatriating profits)Can hurt national sovereignty & national defense(depending on the defense)Parts imported for assembly hurt tradeHome Country FDI Problems…Job lossIssue the Trump administration is most concerned aboutOutsourcing and offshoringCan hurt trade balanceReduces exportsMNC may export to home countryEncouraging FDI…Risk insurance (Home)To deal with political and legal riskElimination of double taxation (Home)Eliminate unfavorable tax treatmentsTax incentives (Host)Provide tax incentives to attract FDILow interest rates (Host)Stable government & policies (Host)Best way to attract FDI*** (Chapter 9: ECONOMIC INTEGRATION)Economic integration is what economists call itRegional Economic IntegrationAgreements among countries in a geographic region to reduce, and ultimately remove, tariff and nontariff barriers to the free flow of goods, services and factors of production among each other.Another attempt to what WTO wants (to facilitate more free trade among member countries)Economic Case for Regional Integration (economic rationale)Allows companies to capitalize on their comparative advantages so they can specialize even moreStimulates economic growth in all participating countriesCountries specialize in those goods and services efficiently produced.Additional gains from free trade beyond international agreements such as GATT and WTO.Political Case for Economic Integration (political rationale: major driving force for EU)(If there are economic links b/w countries, there is incentive to solve problems and not go to war)Economic interdependence creates incentives for political cooperation and reduces potential for violent confrontation.Together, the countries have the economic clout to enhance trade with other countries or trading blocs.have more negotiating power than any other country alone (as a member of the EU)Impediments to Regional Integration (downside)Groups within countries participating in these trade blocs that may be hurt.Remove the artificial protections by trade policies (tarrifs, etc.) and less competitive or efficient firms will suffer because of the new competition (that are not protected anymore)Will also cause unemployment from these kind of companies companies(in regard to capitalism: always a loser, whether short-term or long-term)Potential loss of sovereignty and control over domestic issues.Lose some of economic policy: don’t get to set monetary policies. Cant use fiscal policy, taxing, and standards bc of regulations of EUDebate:Does economic integration result in trade creation or trade diversion?(consequences: issues of trade diversion)trade diversion: implement rules of origin that specify that you can only come freely across the border if it’s a Mexican product (different than trade deflection)trade deflection: pay mexico to avoid tariff. To deal with it: take a step up the “stairs” belowLevels of Economic Integration(every time you take a step you include last step and add new things to make the new step)5 forms of economic integrationfree trade area: movement towards free flow of goods and services…ex: NAFTA 2.0customs union: harmonized external trade policyex: if NAFTA were to go to a customs union, US, Canada, and mexico would have to sit down and come up with a trade negotiation with other countries and spaincommon market: free up restrictions on the flow of resources (allowing resources to cross the border benefits by allowing more efficiency)economic union: harmonized economic policyin Europe- this manifested in the euro. Didn’t have to have euro to become a member of EU, but did have to follow guidelinespolitical union: one governmentno example of thishypothetically: closest ex would be the 50 states. (Imperfect example)(rule of origin: a minimum amount of a product would have to be produced within the trading bloc)Forms of Economic Integration5 forms of integrationThe European Unionmost important trading bloc in terms of size and integrationwhen soviet union collapsed and iron curtain came down, EU started spreading eastturkey is having some problems. Provisionally a member but having problems Turkey’s issues: economics and human rights (still have death penalty: not allowed in EU)Would be first muslim country in EU. If became member, a Turk could move anywhere else in EUBeen going on for a whileFortress Europe(Don’t have to know governing aspects of European Union)**EU Political Structurethe European Commission - proposes EU legislation, implements it, and monitors compliancethe European Council - the ultimate controlling authority within the EU the European Parliament - debates legislation proposed by the commission and forwarded to it by the councilthe Court of Justice - the supreme appeals court for EU lawRationale for the EuroIdea: if all European countries gave up their own currencies and adopted the Euro, it would make it easier to compare priceseasier to compare prices across Europeincreased competition promotes greater efficiencies in productionthe pan-European capital market should further developand reduce the risks of exchange rates and facilitate more investment in Europerange of investment options open both to individuals and institutions should increaseex: if you wanted stock, easier to access(still don’t have to adopt the Euro to be a member of the EU.)English did not do it. Still have pounds as currency methodDenmark has yet to adopt Euro as wellWESTNAFTA: 2nd most important trading bloc (after the EU)Moving WESTNAFTA: North American Free Trade AgreementBecame law: January 1994Over 15 year period:tariffs reduced (99% of goods traded)reduced trade barriersNTBs reducedIncreased FDI opportunitiesinvestment opportunities increasedProtects intellectual propertyApplied national environmental standardsSpecial treatment for many industries, with agriculture being an issue2 big hold ups: agriculture and intellectual propertyaccounts for about 1.2 trillion $ in trade. Ultimately beneficial to all 3 countriesUSMCA (NAFTA 2.0)Us, mexcio, CanadaCore of NAFTA is still in placeCHANGED…Changed the rules of origin on automobiles (75% of car has to be made in NAFTA countries)Changed labor: 40-45% of all auto content minimum wage is $16 per hourProtects mexico. Specifically geared to stop some job loss for cheap labor in mexicoHelps workers in mexico…BUT what will that do to the price of carsAlso provided protection for women and immigrants in MexicoGives the right of union representation to Mexican workersMore US farmer access to CanadaFarmers in U.S. were affectedExtends the intellectual property protectionHelps pharmaceutical No tariffs on e-commerceMaintains the mechanism for dealing with disputesTrade dispute mechanism maintained; limits investors suing governmentsProvision: there will be a periodic review2020: periodic review16 year sunset clause (exit clause)Move more SOUTH:ANCOM: Andean PactBolivia, Colombia, Ecuador and Peru (Venezuela left for Mercusor) Cartagana Agreement, 1969: One of oldest still in existence Changed from FTA to customs union in 1992 Population: 100 million Collective GNP ~ $900 billion4 countries: 3 of which need the economic boostBolivia and Ecuador are dealing with economic issues. Bad economy. Peru is struggling as well.(chile was a member, but they pulled out)The Mercosur AccordBigger of the 2 arrangements in south AmericaBecause contains 2 of the biggest1988: Argentina, Brazil. 1990: Paraguay, Uruguay, and recently, Venezuela1995: Agreed to move toward a full customs union, and goal is to become common market (which is still a long way aways).Population: 250 million (probably wrong)? of South America’s economic activity occurs within this blocTrade doubled in first 3 years after implementationLink to Andean countries:Bolivia, Chile, Colombia, Ecuador & Peru are associate members (FTA, but not in customs union)More EAST:ASEAN: Association of Southeast Asian NationsCreated in 1967 by Indonesia, Malaysia, Philippines, Singapore & Thailand (later joined by Myanmar, Cambodia, Laos and Vietnam) Economic (FTA), political and social cooperationalso trying to slowly move towards a common market about 600 million people Collective GNP ~ $1.8 trillionThe ASEAN Membersaround south-east asia (almost the entirety)(include) Cambodia and laos Asia-Pacific Economic Cooperation Initiative (APEC)not a trade bloc. A loose cooperative organizationRussia is also in it (update)Come together annually to talk about trade and practical cooperation and talk about common concerns (social problems, terrorism, etc)APEC: Asia Pacific Economic CooperationFounded in 1989 to ‘promote open trade and practical economic cooperation’ and a ‘sense of community’21 members (Russia most important recent addition) with combined population of 2.7+ billionGDP (PPP adjusted): $44 trillionOver half of world income and tradeFree Trade Agreements in Africain Africa (3 major trade blocs, segregating the country)idea: the 3 major trade blocs will combine into 1Trans-Pacific Partnership (TPP)(Trump withdrew us from this…Would have been the largest trade agreement)Proposed trade agreement between the U.S. and Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam to increase trade and cooperationProjected benefits would have been $295 billion annuallyInteresting: did more than any trade agreement thus far to protect from …Possible requirements on labor and environmental rules, intellectual property and challenging countries’ regulationsQuestion: will China step in and benefit from what we chose not to step in on?Implications for ManagersQuestion: Why is regional economic integration important to international companies?Markets that had been protected from foreign competition are increasingly open (changes opportunities and threats)Particularly significant in the EU and NAFTA 2.0Increases competitionRegional economic integration means that markets that had been protected from foreign competition are increasingly openthese developments are particularly significant in the European Union and NAFTAHowever, regional economic integration is likely to increase competitionFortress Europe: (around 1980s) going to be hard to get into. Concerned with the idea that it would be harder to get your product into Europe. IDEA: get in before they make it harder to do so. (if you think the bridges will be drawn, try to get in as much as possible. Rush to try and get more foreign direct investment in that country)Suggests trade diversion: policies that favor higher cost producers in the bloc over more efficient producers outside the bloc***(distorts trade) ................
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