Transcript ECONOMICS 3150B

ECONOMICS 3150N
Winter 2013
Professor Lazar
Office: N205J, Schulich
[email protected]
736-5068
1
Lecture 9: March 28
Ch. 8
2
Mobility of Capital
• International capital movements – capital account transactions
– Distinction between physical and financial capital
• Importance of rules – ownership, tax (repatriation of profits)
• Debt instruments – no change in control/ownership
– Covenants restrict behavior of firms
– Transparency, measurement of risk
– Markets for risk
• Equity
–
–
–
–
May change ownership, control
Institutional investors
Sovereign funds
Foreign direct investment
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Mobility of Capital
• H-O Model:
–
–
–
–
2 factors of production – capital (K), labor (L)
2 products – present (Y1) and future (Y2) production of same product
Y1 uses K more intensively
A has relative abundance of K
• Pre-trade:
– {PK/PL}A < {PK/PL}B
– {P1/P2}A < {P1/P2}B
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Mobility of Capital
• Trade in products
– No flows of factors of production; no capital flows  capital account = 0
and exchange rate determined by trade balance which must be = 0
• Migration of L
– From B to A  no capital flows, trade not necessary
• Mobility of K
– From A to B  no labor migration, no trade flows
– During period of capital flows, home country’s currency depreciates;
when capital flows end, no further change in exchange rate and both
current account and capital account = 0
– Future interest, dividend payments from foreign to home; so foreign must
have surplus in trade in goods to offset deficit in trade in services
– Basis for trade in H-O model?
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Direct Foreign Investment
Inflows
(US$ B)
Outflows
(US$ B)
Country
2007
1997
2007
1997
Australia
23.6
7.6
25.7
6.4
Canada
107.4
11.5
49.5
23.1
France
158.0
23.2
224.6
35.6
Germany
50.9
12.2
167.5
41.8
Iceland
25.9
2.7
22.1
1.0
Mexico
23.2
14.2
8.3
NA
Poland
17.6
4.9
3.2
--
Spain
53.4
6.4
119.6
12.5
UK
186.0
33.2
229.9
61.6
US
237.5
105.6
333.3
104.8
Brazil
34.6
19.7
7.1
1.0
Russia
52.5
4.9
45.7
3.2
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Mobility of Capital
• Foreign investment restrictions
– Canada used to have FIRA (Foreign Investment Review
Agency)
• All foreign takeovers involving asset beyond a certain size
were subject to review
• Takeover had to produce benefits for Canada
• S. 20 Investment Canada Act: acceptability tests – enhanced
employment, increased exports, improved productivity, greater
technology development, compatibility with Canada’s national,
industrial and cultural policies
• Weakened over time
• Intervened to stop acquisition of Potash by BHP Billiton
– Limits on SOEs
– Limits continue to exist in transportation, banking,
broadcasting, telecommunications, uranium
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Mobility of Capital
• Foreign investment restrictions
– Competition Policy Review Panel recommends
new screening criteria and removal of foreign
ownership limits in number of industries
(airlines, telecommunications, broadcasting)
• Only review acquisitions worth more than $1 B
• Criterion should be changed from approving deals
demonstrating net benefit to Canada to rejecting
deals that would be contrary to Canada’s national
interest
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Mobility of Capital
• Foreign investment restrictions in most
countries
• Xenophobia
–
–
–
–
Restrictions against Chinese companies
U.S. actions against Dubai Ports
China restricts foreign companies
Major trade barrier going forward out of
recession as companies restructure
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Mobility of Capital
• Ethical funds, green funds – should they be
supported
• Boycotts
• Human rights and sovereign funds
– Should there be investment restrictions on sovereign
funds from countries that do not meet certain human
rights standards?
• Morgan Stanley: $US5 B (5%) stake sold to China Investment
Corporation
• Citigroup: US$7.5 B (4.9%) stake sold to Abu Dhabi
Investment Authority
• UBS: CHF11 B stake to Singapore Investment Corporation
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Existence of Firms
Internalization
• Technological
• Transactions costs
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Existence of Firms
Transactions costs
• Costs in using markets
– Search costs – suppliers, prices
– Negotiating, writing, monitoring and enforcing contracts
• Classical firm as nexus of contracts – hub/spoke
• Duration of contracts and increasing complexity
– Uncertainty re. future states
– Increasing number of contingencies – increasing complexity
– Incomplete contracts – trade-offs between more complex contracts/higher
costs and simpler, incomplete contracts
– Opportunistic behavior – incentives to breach contracts
• Proprietary rights to information – investment ideas, market demands,
product design, service innovations, etc.
– Value depends on package of rights and other factors – cannot contract for
all factors
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Existence of Firms
Options
• Markets and firms alternative means for completing related
sets of transactions
• Short-term contracts – costs, uncertainty re. supply
• Long-term contracts – opportunistic behavior
• Ownership/control – internalization
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Existence of Firms
• Advantages of engaging in market transactions –
outsourcing a new term for an old idea, namely, using the
market to acquire inputs or sell outputs
–
–
–
–
Specialization/focus for firm
Market prices serve as reference points for internal transfer pricing
Economies of scale – ability to serve 3rd party customers
Link between performance/rewards
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Existence of Firms
• Internalization (insourcing) – avoid using marketplace
by ownership of inputs, expansion of value-added
activities conducted within firm
– Bargaining power vis a vis market – credible threat to shift
production
– Inefficiencies as firm becomes larger
• Control problems associated with bounded rationality (limits to
information any person can absorb and massage); weak incentives
(difficulty in measuring direct contributions of individuals or
divisions to overall financial performance of company); distortion as
information (decisions) pass through more levels within organization
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Existence of Firms
Internalization
• Vertical integration, horizontal diversification
• Reduce transactions costs
• Economies of scale, scope
• Transferability of source of competitive advantage (design,
marketing, costs, superior management, reputation)
• Proprietary information
• Tax advantages – transfer pricing
• Quality control – minimize liability risks
• Entry deterrence
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Direct Investment and MNEs
• In traditional trade model, companies operate only in their
home markets
• With MNEs, same companies operate in both home
country and foreign country (home and host countries)
• Question: Why do MNEs exist?
• Question: What is their impact on trade patterns and
volumes?
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Employment in Foreign-Controlled
Affiliates
% of total employment
Manufacturing (2007)
Services (2006)
26%
11%
Germany
16
6
Ireland
46
27
Italy
10
7
Poland
32
20
Portugal
13
8
Spain
16
8
Sweden
33
21
UK
30
13
US
11
5
France
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Direct Investment and MNEs
• Distinction between horizontal foreign investment
– Geographical diversification; that is, production of same product line in at
least one foreign country
• And vertical foreign investment
– Production of intermediate product(s) as inputs(s) into home market
production process (backward or upstream vertical integration)
• Forward or downstream vertical integration also possible with final
production in foreign market
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Direct Investment and MNEs
• Basic assumptions:
– Two countries
– Per unit production costs expressed in same currency: (A), (B)
– Per unit export marketing differential: t
• Difference between export and domestic marketing costs
• Export marketing costs include: shipping, insurance, finance (working
capital), communications, sales, tariffs, NTMs
– Per unit transfer costs: 
• Extra costs of operating across national boundaries – coordination/control
problems with subsidiaries
• Hierarchical structure of companies and diseconomies of scale
• Different legal, political, cultural, social environment
– Firm specific knowledge assets per unit: 
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Direct Investment and MNEs
• t===0
– H-O world of domestic firms with no trade barriers
• t>0
– H-O world with trade barriers
• t > 0,  > 0,  > 0
– World of MNEs
– Importance of competitive advantage
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Direct Investment and MNEs
A
B
Parent Firm
Foreignowned sub
Domestic
Firm
Production
costs
(A)
(A)*
(B)
Export
marketing
t(A)
t(A)*
t(B)
Transfer costs
(A)*
Firm specific
(B)
Transactions
costs
(B)
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Horizontal Foreign Investment
• Why do firms choose to enter foreign countries as producers rather
than exporters
– Foreign investment substitutes for exports from home country
• Conditions:
– Subsidiary in B of parent firm in A has lower costs for serving market in
B than domestic firm in B
– (A)* + (A)* < (B) + (B)
– Subsidiary in B has lower costs than parent in A
– (A)* + (A)* < (A) + t(A)
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Horizontal Foreign Investment
• More on firm specific advantages – competitive advantage
• Firm specific competitive advantage: superior knowledge re.
technology (production processes, product innovation), management
and organization skills, marketing; reputation 
– Lower costs, differentiation advantage
• Superior knowledge result of past investments, luck and management
skills  benefits transferable to subsidiary at low marginal cost
– Foreign competitors must overcome advantage by making similar
investments
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Foreign Production vs. Licensing
• Avoid the costs of (A)*
– Some of the knowledge asset may not be transferable, e.g. capacity to
create new technology, skills associated with management, organization
and marketing intimately linked to ongoing operations of MNE and its
subsidiaries – source of competitive advantage cannot be separated
completely for transfer to outsiders
– Full economic rent may not be available via transfer because competitive
advantage of entire package (including foreign production, distribution,
etc.) > sum of the parts
– Licensee firm may not appreciate full value of assets because of market
ignorance, uncertainty, lack of complementary assets
– Limited competition on foreign market for license – monopsony
– Possibility of creating future competitors
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Vertical Foreign Investment
• Foreign investment does not replace exports; replaces
foreign suppliers of inputs or distribution services 
changes ownership of company that exports
• Comparative advantage for foreign country in production
of intermediate product/input
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Vertical Foreign Investment
• Why do firms choose to enter foreign countries rather than outsource
– Foreign investment substitutes exports from foreign company to
subsidiary in host country
• Conditions:
– Subsidiary in B of parent firm in A has lower costs for supplying parent in
A than domestic firm in B
– (A)* + (A)* +t(A)* < (B) + (B) + t(B) + (B)
– Subsidiary in B has lower costs than parent in A
– (A)* + (A)* + t(A)* < (A)
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Economic Effects of MNEs
• Intra-firm trade
• Transfer of rents – quasi-monopoly rents repatriated to home country
(future imports of services of capital)
– Capital export when foreign investment made; future service imports
when profits transferred
• Subsidiary may use inefficient technology because parent familiar with
limited number of technologies
– Most appropriate for relative price structure for factors of production in
home country – and unwilling to experiment  high production costs,
inefficient use of factors of production in foreign country
– Subsidiaries export capital-intensive products when relative prices of
inputs suggest that exports should be labor-intensive
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Economic Effects of MNEs
• Head office employment (skilled labor) and decisionmaking
– R&D, technology development  dynamic productivity gains
– Spin-offs for for suppliers – proximity important  development
of industrial clusters and economies of scale
• Technology transfer – improvements in productivity of
factors of production in foreign country
• Increased competition – allocative efficiency
• Competition for investment by MNEs – tax concessions,
exemptions from environmental, labor laws
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Economic Effects of MNEs
• Lower value of life  more dangerous work practices, more
environmental damages
– Reputation effects – sweatshop production
• Increased specialization in production
• Support tyrants
• Integration of production and world markets – exports/imports in each
country
– Moves closer to H-O world
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Industrial Policy
 Comparative advantage can be created by combination of government
policies and corporate competitive strategies – investment in skilled
labor, specialized forms of capital, R&D/technology
• Competitive advantage vs. comparative advantage
• Infant industry argument – market failures
• Economic freedom
• Porter: Competitive advantage of nations
– Factor endowments
– Demand conditions – sophisticated domestic market  better quality
goods with higher income elasticities
– Firm strategy and rivalry – strong rivalry  innovative firms
– Related and supporting industries – industrial clusters  economies of
scale, agglomeration benefits
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Industrial Policy
• Comparative advantage can change over time:
– Changes in relative supplies/productivities of factors of production
– Changes in technology
– Country-specific
• Competitive advantage – firm/ownership advantages to compete in
foreign markets
– Technological capacity, entrepreneurial talents
– Product innovations – new varieties, change in tastes
– First mover advantages and learning curve
• Country-specific characteristics can generate/sustain form-specific
advantages – e.g. government policies re. investment in R&D, capital
gains taxation, training
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Industrial Policy
• R&D as factor of production
– Comparative advantage in R&D-intensive products not predetermined; combination of following
– Firm specific advantages
– Country-specific advantages
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R&D
• Growth in real GDP per capita
– Static (one-time gains) free trade gains including specialization,
economies of scale, increased competition and decrease in X-inefficiency,
increase in number of varieties
– Dynamic gains – innovation, learning curves
– Growth in in real income per capita: growth in capital per capita;
productivity growth (residual)
•
•
•
•
Productivity growth most important
Learning curves
Improvements in management
Improvements in utilization of labor and capital
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R&D Expenditures as % of GDP (2007)
Belgium
2.5%
Portugal
1.2
Canada
1.9
Spain
1.3
Denmark
2.6
Sweden
3.6
France
2.0
Turkey
0.7
Germany
2.5
UK
1.8
Greece
0.6
US
2.7
Ireland
1.3
EU27
1.8
Italy
1.2
OECD
2.3
Japan
3.4
Brazil
1.1
S. Korea
3.2
China
1.4
Mexico
0.4
India
0.9
Norway
1.6
Russia
1.1
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Industrial Policy
• Objective of industrial policy: engineering competitive
advantage to increase growth rate of real Y per capita
(growth rate of productivity)
• Industrial policy must correct market failures – otherwise,
functioning of markets (continuous search for unexploited
opportunities/economic rents) will maximize growth rate
of real GDP per capita
36