Transcript Introduction

Chapter 10: Foreign Direct
Investment and Intra-Firm Trade
An Introduction to International
Economics: New Perspectives on the
World Economy
© Kenneth A. Reinert, Cambridge University
Press 2012
Analytical Elements
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Countries
Sectors
Tasks
Firms
© Kenneth A. Reinert, Cambridge University
Press 2012
Value Chains
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A value chain is a series of value-added processes
involved in the production of any good or service
Consider a semiconductor value chain
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Research, development and design leading up to details of the
physical circuitry of the chip to be placed on the silicon
Fabrication (or just fab in semiconductor jargon) in an advanced
manufacturing process in which circuitry layouts are etched onto
silicon wafers containing many die
Assembly and testing in which the die are cut from wafers and
mounted or packaged into a functioning device with wire contacts
and insulation
Final incorporation in which the semiconductor is incorporated
into the final piece of equipment such as a personal computer or
mobile phone
© Kenneth A. Reinert, Cambridge University
Press 2012
Semiconductor Value Chain
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The semiconductor value chain is shown in Figure 10.1
An additional task in this figure is that of advanced
equipment and materials crucial to the fabrication
process
It is not necessary for a firm to be active across all
stages of semiconductor manufacturing
The task scope of a firm in the industry is the result of a
firm’s decision-making with regard to what tasks to
perform along the value chain
Intel is involved in the first three stages of the value
chain: research, development and design; fabrication;
and assembly and testing
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 10.1: A Value Chain for
Semiconductors
© Kenneth A. Reinert, Cambridge University
Press 2012
Global Production Networks
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Value chains are potentially distributed across countries.
When these international value chains are linked
together in potential buyer-supplier or ownership
relationships, they become known as global production
networks or GPNs
An example of this is given in Figure 10.2
The semiconductor production decision is two-fold,
namely the decision as to what part of the value chain to
take on and in which countries to do so
There are both task and location decisions to consider
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 10.2: A Global Production Network
for Semiconductors
© Kenneth A. Reinert, Cambridge University
Press 2012
Movements along GPNs
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There is another way to look at the GPN decisionmaking process
Movements up and down the value chains of Figure
10.2, whether in the United States or Costa Rica, are
vertical movements
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Movements up a value chain, from subsequent to previous tasks
are backward vertical movements
Movements down a value chain from previous to subsequent
tasks are forward vertical movements
Movements from one country to another, from the United
States to Costa Rica, for example, are horizontal
movements
© Kenneth A. Reinert, Cambridge University
Press 2012
Firm-Specific Assets
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Firms can and do take more than one approach to the
semiconductor value chain or GPN
A simplified version of Intel’s semiconductor GPN is
presented in Figure 10.3
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The dashed lines indicate potential areas where Intel has chosen
not to operate
The ability of Intel to operate where it does in its GPN
reflects its competiveness
International business researchers explain
competitiveness with reference to firm-specific assets
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 10.3: A Global Production Network
for Semiconductors
© Kenneth A. Reinert, Cambridge University
Press 2012
Intel’s Plant in Costa Rica (Source:
Wikipedia)
© Kenneth A. Reinert, Cambridge University
Press 2012
Firm-Specific Assets
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Firm-specific assets can be tangible
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Firm specific assets can also be intangible
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Access to silicon and other advanced materials,
Specialized knowledge, patented products or processes,
organizational abilities, or brand distinctiveness and loyalty
When a firm such as Intel takes on new tasks along the
vertical dimension of a GPN, it can experience an
efficiency gain by spreading the costs incurred in
acquiring its firm-specific assets (both tangible and
intangible) over more value chain stages
These efficiency gains are known as firm-level
economies
© Kenneth A. Reinert, Cambridge University
Press 2012
Firm-Level Economies
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The concept of firm-level economies is not, in general,
sufficient to explain the integration process along GPNs
Why? Because firms always have the option (discussed
in Chapter 9) of licensing its firm-specific assets to other
firms
Corporate strategists suggest that a firm’s decision to
internalize the firm-specific asset market reflects market
failure
That is, for a number of reasons, it has difficulty in selling
its firm-specific assets in a contractual arrangement
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This difficulty is particularly acute for intangible assets
© Kenneth A. Reinert, Cambridge University
Press 2012
Intra-Firm Trade
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We can observe a pattern of intra-firm trade in Figure
10.3
Intel exports fabricated die from its home base to its
subsidiary in Costa Rica
This is not an arm’s-length, market-based transaction
that takes place at world prices
It is a trade transaction within Intel itself at a price set by
it
We now have two distinctions of trade (Table 10.1)
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Inter-industry vs. intra-industry
Inter-firm vs. intra-firm
© Kenneth A. Reinert, Cambridge University
Press 2012
Table 10.1: Industry and Firm Dimensions
of Trade
Firm Dimension
Industry Dimension
Inter-firm
Intra-firm
Inter-industry
Trade that takes place
between two different
industries and two
different firms
Trade that takes place
between two different
industries and within a
single firm
Intra-industry
Type of trade that takes
place within a single
industry and between
two different firms
Trade that takes place
within a single industry
and within a single firm
© Kenneth A. Reinert, Cambridge University
Press 2012
A Cost View of Internalization
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Suppose that a home-country firm faces a fixed cost of
setting up a production facility in country of FPj
Suppose also that the firm faces a smaller fixed cost of
establishing a contractual relationship with a firm from
country of FCj.
There are also variable costs associated with these two
options of VPj and VCj
The variable costs of international contracting are larger
than the variable costs of international production due to
the firm-specific assets that give it an advantage over the
potential contracting partner.
© Kenneth A. Reinert, Cambridge University
Press 2012
A Cost View of Internalization
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In Figure 10.4, the solid FPj+VPj graph begins at the
vertical axis intercept equal to the fixed cost of
production and increases from there with a slope equal
to the variable costs of production.
The solid FCj+VCj graph begins at a lower vertical axis
intercept equal to the lower fixed cost of contracting and
increases from there with a slope equal to the variable
costs of contracting
The two solid lines intersect at a “breakeven point” that
establishes a boundary between quantities where it
would be better for the firm to engage in contracting and
quantities where it would be better for the firm to engage
in production
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 10.4: A Cost Analysis of
Production and Contracting
© Kenneth A. Reinert, Cambridge University
Press 2012
The OLI Framework
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We can tie together some of the considerations of this
chapter into what has be come known as the OLI
Framework
If the home-country MNE is indeed able to successfully
engage in business in the foreign country, there must be
some other advantages that offset the additional costs of
conducting business internationally
These advantages are what John Dunning called
ownership or O advantages
The role of the O advantage is to explain why the MNE
engages in the production of a good for the foreign
market instead of a foreign firm.
© Kenneth A. Reinert, Cambridge University
Press 2012
The OLI Framework
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Location or L advantages are associated with the foreign
country
The L advantages could include input costs,
transportation costs, import restraints, foreign
government promotional policies, or access to foreign
consumers
The role of the L advantage is to explain why the homecountry MNE chooses to produce in the foreign country
rather than the home country
© Kenneth A. Reinert, Cambridge University
Press 2012
The OLI Framework
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Internalization or I advantages explain why the homecountry MNE chooses FDI over the contracting option
The I advantages are therefore related to all the reasons
why contracting might not be a viable option
In Dunning’s view, and in the view of other researchers
deploying this framework, all three advantages are
necessary to explain the presence of FDI
The OLI Framework is summarized in Table 10.2
© Kenneth A. Reinert, Cambridge University
Press 2012
Table 10.2: The OLI Framework
Symbol
Meaning
Contribution
O
Ownership
advantage
Explains how a firm’s tangible and intangible
assets help it to overcome the extra costs of
doing business internationally. Explains why
a home country firm, rather than a foreign
firm, produces in the foreign country.
L
Location
advantage
Explains why a home-based MNE chooses to
produce in a foreign country rather than in its
home country.
I
Internalization
advantage
Explains why a home-based MNE chooses
FDI rather than licensing to achieve
production in a foreign country.
Source: Dunning (1988)
© Kenneth A. Reinert, Cambridge University
Press 2012
Appendix: The Gravity Model
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Gravity models utilize the gravitational force concept as
an analogy to explain the volume of trade or FDI among
the countries of the world
For example, gravity models establish a baseline for
trade or FDI flows as determined by gross domestic
product (GDP), population and distance
The effect of policies on trade or FDI flows can then be
assessed by adding the policy variables to the equation
and estimating deviations from the baseline flows
© Kenneth A. Reinert, Cambridge University
Press 2012
Appendix: The Gravity Model
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Gravity models are estimated in terms of natural
logarithms, denoted “ln”
Gravity models explain trade flows or FDI flows from
county i to country j (Fij) in terms of GDP and distance
A simple gravity model is given by
lnFij =  + 1lnGDPi + 2lnGDPj + 3lnDij
In this model, 1 and 2 are expected to be positive and
3 is expected to be negative
© Kenneth A. Reinert, Cambridge University
Press 2012