Transcript Chapter 12 International resource Movements and MNCs

International Resource
Movements & MNCs
Chapter 12
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Key Terms
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Portfolio investment
Direct investment
Risk diversification
Horizontal integration
Vertical integration
Multinational corporation
Transfer pricing
Brain drain
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1 Introduction

Discuss the motives for portfolio and direct
investments abroad.
 Know the welfare effects of international
capital flows on investing and host countries.
 Learn Multinational corporations—the reasons
for their existence and some of the problems
they create.
 Ananlyze the reasons for and welfare effects of
the international migration of labor in general
and of skilled labor in particular.
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2 International Trade and
Movement of Resources
International trade and movements of
productive resources can be regarded as
substitutes for one another.
International trade and movements of
productive factors have very different economic
effects on the nations involved.
There are two main types of foreign
investments:
Portfolio investments
and direct investments.
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2 Portfolio Investments and
Direct Investments
Portfolio investments are purely financial assets, such as
bonds and stocks, denominated and expressed in a national
currency. They take place primarily through financial
institutions (banks and investment funds).
With bonds, the investor simply lends capital to get fixed
payouts or a return at regular intervals and then receives the
face value of the bond at a prespecified date.
With stocks, the investor purchases equity on the net worth
of the firm.
Direct investments are real investments in factories, capital
goods, land, and inventories where both capital and
management are involved and the investor retains control over
use of the invested capital. Direct investment usually takes the
form of a firm starting a subsidiary or taking control of another
firm (by purchasing a majority of the stock).
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2.1 Motives for International
Portfolio Investments
The basic motives are:
 To earn higher returns abroad.
 To reduce risks to account for the two-way capital
flows.
Investors are interested not only in the rate of return
but also in the risk associated with a particular
investment. The risk with bonds consists of bankruptcy
and the variability in their market value. With stocks, the
risk consists of bankruptcy, even greater variability in
market value, and the possibility of lower than anticipated
returns. Thus, investors maximize returns for a given
level of risk and generally accept a higher risk only if
returns are higher.
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2.2 Example of Portfolio Investment
Suppose stocks A and B both have a rate of return of
30 percent on average, but there is a fifty-fifty chance that
the yield will be either 20% or 40% on stock A and 10
percent or 50 percent on stock B. Stock B is then clearly
riskier than stock A. Since both stocks have the same
yield on the average, investors should purchase stock A
to minimize risks.
If the yield on stock A falls when the yield on stock B
rises and vice versa, then by holding both stocks, the
investor can still receive a yield of 30% on average but
with a much lower risk. The risk of a lower than average
yield on stock A is more or less matched by the yield on
stock B to be higher than average. As a result, the risk of
a portfolio including both stock A and stock B is reduced.
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2.2 Example of Portfolio Investment
Portfolio theory thus tells us that by investing
in securities with yields that are inversely related
over time, a given yield can be obtained at a
smaller risk or a higher yield can be obtained for
the same level of risk for the portfolio as a whole.
Since yields on foreign securities (depending
primarily on the different economic conditions
abroad) are more likely to be inversely related to
yields on domestic securities, a portfolio
including both domestic and foreign securities
can have a higher average yield and/or lower risk
than a portfolio containing only domestic
securities.
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3 Motives for FDI
The motives are the same as for portfolio investments:
to earn higher returns and to diversify risks.
To get higher returns from higher growth rates abroad,
more favorable tax treatment, or greater availability of
infrastructures.
They have unique production or managerial skills that
could easily and profitably be utilized abroad and over
which the corporation wants to retain direct control. This
is horizontal integration, the production abroad of a
differentiated product that is produced at home.
To obtain control of needed raw materials and ensure
an un-interrupted supply at lowest possible cost. This
involves vertical integration and is the form of most FDI
in developing countries and in some mineral-rich
developed countries.
 To avoid tariffs and restrictions that nations impose on
imports or to take advantage of various government
subsidies to encourage FDI.
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3.1 Welfare Effects of Capital Flows
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3.2 Other Effects on Investing &
Host Nations
Redistribution Effects
The total and average return on capital increases,
whereas the total and average return to labor decreases
in the investing country.
The host country also gains from receiving foreign
investments, these investments lead to a redistribution of
domestic income from capital to labor. FDI tends to
reduce the level of employment in the investing country
and increase employment in the host country.
The Balance of Payments
A nation's balance of payments measures its total
receipts from and total expenditures to the rest of the
world. In the year in which the foreign investment takes
place, the foreign expenditures of the investing country
increase and cause a balance-of-payments deficit.
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4 Reasons for Existence of MNCs
The basic reason is to achieve the competitive
advantage of a global network of production and
distribution.
This competitive advantage arises from vertical and
horizontal integration with foreign affiliates.
By horizontal integration through foreign affiliates,
MNCs can better protect and exploit their monopoly
power, adapt their products to local conditions and
tastes, and ensure consistent product quality.
The competitive advantage of MNCs also comes from
economies of scale in production, financing, R&D, and
the gathering of market information.
The large output of MNCs allows them to carry division
of labor and specialization in production much further
than smaller national firms.
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4.1 Problems in Home Country
The most alleged harmful effects of MNCs on
the home nation is the loss of domestic jobs
resulting from foreign direct investments. But
they alsocreate some better jobs
FDI may undermine the technological
superiority and future of the home nation.
Another harmful effect of MNCs can result from
transfer pricing and similar practices, and from
shifting their operations to lower-tax nations,
which reduce tax revenues and erode the tax
base of the home country.
MNCs can circumvent domestic monetary
policies and make government control over the
economy in the home nation more difficult.
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4.2 Problems in Host Country
MNCs dominate the economies in host countries including
(1) Unwillingness of a local affiliate to export to a nation
which is friendly to the host nation but unfriendly to the
home nation;
(2) Borrowing of funds abroad to circumvent tight
domestic credit conditions and the lending of funds
abroad when interest rates are low at home;
(3) Effects on national tastes of large-scale advertising
for such products as Coca-Cola, jeans, and so on.
(4) Siphoning off of R&D funds to the home nation.
While this may be more efficient for the MNC and the
world as a whole, it also keeps the host country
technologically dependent.
(5) Absorbing local savings and entrepreneurial talent.
(6) Extract benefits either through tax and tariff benefits
or through tax avoidance.
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5 Motives for International
Labor Migration
Migration takes place for: Economic Reasons and noneconomic Reasons.
 Economics Reasons: prospect of earning higher real
wages and income abroad.
 Non-economic Reasons: greater educational and job
opportunities for children.
Costs:
 Expenditures for transportation and the loss of wages;
 Separation from relatives, friends, and familiar
surroundings;
 Need to learn new customs and often a new language;
 Risks involved in finding a job, housing, and so on in a
new land.
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6 Welfare Effects of International
Labor Migration
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7 Discussion Questions
• In what sense are international flows of production
resources a substitute for international commodity
trade?
• What is meant by portfolio investment? What are the
basic motives for international portfolio investment?
• What is FDI? What are the reasons for FDI?
• What are the effects of FDI on the investing and host
nations?
• What are the motives for the existence of MNC?
• What are the effects of MNCs on the investing and
host nations?
• What are the reasons for labour migration?
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Thank You!
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