12 - International Resource Movements & MNCs...

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Unformatted text preview: International Resource Movements & MNCs Chapter 12 ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 1/18 Key Terms • • • • • • • • Portfolio investment Direct investment Risk diversification Horizontal integration Vertical integration Multinational corporation Transfer pricing Brain drain ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 2/18 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. ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 3/18 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. ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 4/18 2 Portfolio Investments and Direct Investments Portfolio investments are purely financial assets, such as Portfolio 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 bonds, payouts or a return at regular intervals and then receives the face value of the bond at a prespecified date. face With stocks, the investor purchases equity on the net worth stocks, of the firm. Direct investments are real investments in factories, capital Direct 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). ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 5/18 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 two-way 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 and 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. returns ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 6/18 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. to 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. ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 7/18 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. ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 8/18 3 Motives for FDI The motives are the same as for portfolio investments: The to earn higher returns and to diversify risks. To get higher returns from higher growth rates abroad, To more favorable tax treatment, or greater availability of infrastructures. 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 horizontal the differentiated product that is produced at home. differentiated To obtain control of needed raw materials and ensure To an un-interrupted supply at lowest possible cost. This involves vertical integration and is the form of most FDI vertical 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. ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 9/18 3.1 Welfare Effects of Capital Flows ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 10/18 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. ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 11/18 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. ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 12/18 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. ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 13/18 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; home (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. for (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. or ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 14/18 5 Motives for International Labor Migration Migration takes place for: Economic Reasons and nonMigration Economic economic Reasons. Economics Reasons: prospect of earning higher real Economics wages and income abroad. Non-economic Reasons: greater educational and job Non-economic opportunities for children. Costs: Costs: Expenditures for transportation and the loss of wages; Expenditures 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. ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 15/18 6 Welfare Effects of International Labor Migration ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 16/18 7 Discussion Questions • In what sense are international flows of production In resources a substitute for international commodity trade? trade? • What is meant by portfolio investment? What are the What basic motives for international portfolio investment? basic • What is FDI? What are the reasons for FDI? • What are the effects of FDI on the investing and host What nations? • What are the motives for the existence of MNC? • What are the effects of MNCs on the investing and What host nations? host • What are the reasons for labour migration? ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 17/18 Thank You! ANHUI UNIVERSITY OF FINANCE AND ECONOMICS 18/18 ...
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