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MBA 713 - Chapter 06
- 1. Chapter 6 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 1 International Trade and Investment
- 2. • Learn the motives for international trade • Summarize and discuss the differences among classical country-based theories of international trade • Use the modern firm-based theories of international trade to describe global business strategies Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 2 Learning Objectives
- 3. Learning Objectives • Describe and categorize the different forms of international investment • Explain the reasons for foreign direct investment • Summarize how supply, demand, and political factors influence foreign direct investment Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 3
- 4. International Trade and the World Economy Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 4
- 5. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 5 Both Parties Benefit Why Does International Trade Occur?
- 6. USA 8.5% Canada 2.5% Others 38.0% China 9.6% Japan 4.7% EU 36.7% Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 6 Sources of the World’s Merchandise Exports 2009
- 7. Summary of Discussion Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 7
- 8. Classical Country-Based Trade Theories Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 8
- 9. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 9 Mercantilism • Gold and Silver • Increased Exports • Reduced Imports
- 10. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 10 Effects of Mercantilism Opportunities Challenges Stimulates Sales Manages Competition Higher Taxes Higher Prices
- 11. Modern Mercantilism Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 11 Protectionists Neomercantilists
- 12. Absolute Advantage Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 12 Country’s Level of Productivity Import Goods and Services Export Goods and Services More Productive Than Other Countries Less Productive Than Other Countries
- 13. Comparative Advantage Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 13 Country’s Level of Productivity Import Goods and Services Export Goods and Services Relatively More Productive Than Other Countries Relatively Less Productive Than Other Countries
- 14. Comparative Advantage with Money Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 14 Specialization Producing and Exporting Buying Goods and Services
- 15. Comparative Advantage with Money: An Example Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 15 Products Cost of Goods in France Cost of Goods in Japan French Made Japanese Made French Made Japanese Made Bottle of Wine €3 €8 ¥375 ¥1,000 Clock Radio €2 €1.6 ¥250 ¥200
- 16. Heckscher-Ohlin Theory Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 16 Theory of Relative Factor Endowments Comparative Advantage Abundant Factors of Production Scarce Factors of Production Yes No
- 17. Leontief Tests the Heckscher-Ohlin Theory Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 17 Abundant Capital + Labor Scarcity Exporting Capital- Intensive Goods = Assumptions About U.S. Economy
- 18. The Leontief Paradox Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 18
- 19. Summary of Discussion Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 19
- 20. Modern Firm-Based Trade Theories Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 20
- 21. Product Life Cycle Theory Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 21 1. New Product Stage 2. Maturing Product Stage 3. Standardized Product Stage
- 22. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 22 Types of Trade Intraindustry Interindustry
- 23. Country Similarity Theory Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 23 Intraindustry Trade in Goods Similar Consumer Preferences Similar Per Capita Incomes
- 24. Economies of Scale • Owning Intellectual Property Rights • Investing in Research and Development • Achieving Economies of Scope • Exploiting the Experience Curve Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 24 New Trade Theory
- 25. Porter’s Theory of National Competitive Advantage Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 25 •Factor Conditions •Demand Conditions •Related and Supporting Industries •Firm Strategy, Structure, and Rivalry
- 26. Summary of Discussion Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 26
- 27. An Overview of International Investment Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 27
- 28. International Investing Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 28 Foreign Portfolio Investments (FPI) Foreign Direct Investments (FDI)
- 29. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 29 Stock of FDI for the United States, end of 2010 (billions of dollars) Categories Total FDI in the United States $2342.8 FDI from the United States $3908.2 Foreign Direct Investment and the United States
- 30. $0 $800 $1,600 $2,400 $3,200 $4,000 $4,800 1998 2002 2006 2010 Foreign FDI US FDI Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 30 Outward and Inward U.S. FDI (in billions of USD)
- 31. Summary of Discussion Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 31
- 32. International Investment Theories Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 32
- 33. Ownership Advantages Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 33 Superior Technology Well-Known Brand Name Economies Of Scale Penetrate Foreign Markets
- 34. Internalization Theory Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 34 Internalize InternationalizeLow High High Low TransactionCosts TransactionCosts
- 35. Dunning’s Eclectic Theory Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 35 Ownership Advantage Conditions for FDI Internalization Advantage Location Advantage
- 36. Summary of Discussion Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 36
- 37. Factors Influencing Foreign Direct Investment Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 37
- 38. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 38 Production Costs Logistics Natural Resources Key Technology Supply Factors
- 39. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 39 Customer Access Marketing Advantages Competitive Advantages Customer Mobility Demand Factors
- 40. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 40 Political Factors Trade Barriers Economic Incentives
- 41. Summary of Discussion Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 41
- 42. Chapter 6 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 42 International Trade and Investment
- 43. Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 6 - 43 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.
Notes de l'éditeur
- In this chapter, we analyze the underlying economic forces that shape and structure international business transactions. We alsodiscuss the major theories that explain and predict international trade and investment activity. These theories can help firms sharpen their global business strategies, identify promising export and investment opportunities, and react to threats posed by foreign competitors.
- This chapter’s learning objectives include the following:Understanding the motivation for international trade. Summarizing and discussing the differences among the classical country-based theories of international trade. Using the modern firm-based theories of international trade to describe global strategies adopted by businesses.
- Additional learning objectives include:Describing and categorizing the different forms of international investment.Explaining the reasons for foreign direct investment.Summarizing how supply, demand, and political factors influence foreign direct investment.
- Trade is the voluntary exchange of goods, services, assets, or money. Because it is voluntary, both parties to the transaction believe they will gain from the exchange, or they will not complete it. International trade involves the exchange of goods and services between residents of two countries. The residents may be individuals, firms, not-for-profit organizations, or other forms of associations.
- Why does international trade occur? The answer follows directly from our definition of trade: Both parties to the transaction, who happen to reside in two different countries, believe they benefit from the voluntary exchange. Behind this simple truth lies much economic theory, business practice, government policy, and international conflict—topics we cover in this and the next four chapters.
- World trade has grown dramatically in the half century since the end of World War II. Total international merchandise trade in 2009 was $12.5 trillion, or approximately 21 percent of the world’s $58.2 trillion gross domestic product (GDP). As this pie chart shows, the European Union, the United States, Canada, and Japan accounted for 52.4 percent of the world’s merchandise exports; China, 9.6 percent; and other countries, 38 percent. Such international trade affects national economies, both directly and indirectly. On the one hand, exports spark additional economic activity in the domestic economy. On the other hand, imports pressure domestic suppliers to cut their prices and improve their competitiveness. Failure to respond to foreign competition may lead to closed factories and unemployed workers.
- This section focused on International Trade and the World Economy by explaining why international trade occurs and reviewing the sources of the world’s merchandise exports for 2009. The next section will review Classical Country-Based Trade Theories.
- The first theories of international trade developed with the rise of the great European nation-states during the sixteenth century. These early theories focused on the individual country in examining patterns of exports and imports. These country-based theories are particularly useful for describing trade in commodities—standardized, undifferentiated goods such as oil, sugar, or lumber that are typically bought on the basis of price rather than brand name. However, as multinational corporations (MNCs) rose to power in the middle of the twentieth century, scholars shifted their attention to the firm’s role in promoting international trade. The firm-based theories developed after World War II are useful in describing patterns of trade in differentiated goods—such as automobiles, consumer electronics, and personal care products, for which brand name influences the customer’s purchase decision. In this section, we examine the classical country-based theories of international trade. In the next section, we explore the more modern firm-based theories.
- Mercantilism is a sixteenth-century economic philosophy that maintains that a country’s wealth is measured by its holdings of gold and silver. According to this philosophy, if foreigners buy more goods from a country than it buys from them, then they must pay the difference in gold and silver to that country. Those payments will allow that country to amass more treasure. According to mercantilists, a country’s goal should be to enlarge these holdings by promoting exports and discouraging imports.
- Mercantilism was popular with many manufacturers and their workers. Export-oriented manufacturers favored mercantilist trade policies, such as subsidies or tax rebates, which stimulated sales to foreigners. Domestic manufacturers threatened by foreign imports endorsed mercantilist trade policies, such as tariffs or quotas, which protected them from foreign competition. Most members of society, however, are hurt by such policies. Governmental subsidies of the exports of certain industries are paid by taxpayers in the form of higher taxes. Furthermore, import restrictions are paid for by consumers in the form of higher prices because domestic firms face less competition from foreign producers.
- Because mercantilism does benefit certain members of society, mercantilist policies are still politically attractive to some firms and their workers. Modern supporters of such policies, called neomercantilists or protectionists, include such diverse U.S. groups as labor unions, textile manufacturers, steel companies, sugar growers, and peanut farmers.
- In 1776, Adam Smith, a Scottish economist, asserted that mercantilism weakens a country. Instead, he advocated free trade among countries as a means of enlarging a country’s wealth. He believed that free trade enables a country to expand the amount of goods and services available to it by specializing in the production of some goods and services and trading for others. But which goods and services should a country export and which should it import? To answer this question, Adam Smith proposed the theory of absolute advantage. According to this theory, a country should export those goods and services for which it is more productive than other countries are and import those goods and services for which other countries are more productive than it is.
- What happens to trade if one country has an absolute advantage in both products? The theory of absolute advantage incorrectly suggests that no trade would occur. David Ricardo, an early-nineteenth-century British economist, solved this problem by developing the theory of comparative advantage. This theory states that a country should produce and export those goods and services for which it is relatively more productive than other countries are. That same country should import those goods and services for which other countries are relatively more productive than it is.The difference between the two theories is subtle: Smith’s theory looks at absolute productivity differences; Ricardo’s theory looks at relative productivity differences. The distinction occurs because comparative advantage considers the concept of opportunity cost—the value of what is given up to get a good. Ricardo incorporates this concept into the determination of what goods a country should produce.
- The lesson of the theory of comparative advantage is simple but powerful: You are better off specializing in what you do relatively best. Produce (and export) those goods and services you are relatively best able to produce, and buy other goods and services from people who are relatively better at producing them than you are.
- This table illustrates competitive advantage with money. As you can see, a bottle of wine in France costs €3, the equivalent of ¥375 in Japan, and a clock radio costs €2, the equivalent of ¥250. In Japan a bottle of wine costs ¥1,000, the equivalent of €8, and a clock radio costs ¥200, the equivalent of €1.60.Trade will occur because of the self-interest of individual entrepreneurs (or the opportunity to make a profit) in France and Japan. Suppose buyers for a major Paris department store, observe that a clock radio costs €2 in France and the equivalent of only €1.60 in Japan. To keep their cost of goods low, these buyers will acquire clock radios in Japan, where they are cheap, and sell them in France, where they are expensive. Accordingly, clock radios will be exported by Japan and imported by France, just as the law of comparative advantage predicts. Similarly, wine distributors in Japan observe that a bottle of wine costs ¥1,000 in Japan but the equivalent of only ¥375 in France. To keep their cost of goods as low as possible, buyers for Japanese wine distributors will buy wine in France, where it is cheap, and sell it in Japan, where it is expensive. Wine will be exported by France and imported by Japan, as predicted by the law of comparative advantage. None of these businesspeople needed to know anything about the theory of comparative advantage. They merely looked at the price differences in the two markets and made their business decisions based on the desire to obtain productsat the lowest possible cost.
- The theory of comparative advantage begs a broader question: What determines the products for which a country will have a comparative advantage? To answer this question, two Swedish economists, Heckscher and Ohlin, developed the theory of relative factor endowments, now known as the Heckscher-Ohlin Theory.These economists made two basic observations: Factor endowments (or types of resources) vary among countries.Goods differ according to the types of factors that are used to produce them.According to this theory, a country will have a comparative advantage in producing products that intensively use resources (factors of production) it has in abundance.
- The Heckscher-Ohlin was tested empirically after World War II by economist Wassily Leontief using input-output analysis, a mathematical technique for measuring the interrelationships among the sectors of an economy. Leontief believed the United States was a capital-abundant and labor-scarce economy. Therefore, according to the Heckscher-Ohlin theory, he reasoned that the United States should export capital-intensive goods, such as bulk chemicals and steel, and import labor-intensive goods, such as clothing and footwear.
- In 1947, Leontief used his input-output model of the U.S. economy to estimate the quantities of labor and capital needed to produce weighted-average “bundles” of U.S. exports and imports worth $1 million. He determined that U.S. factories utilized $2.551 million of capital and 182.3 person-years of labor (or $13,993 of capital per person-year of labor) to produce a bundle of exports worth $1 million. He also calculated that $3.093 million of capital and 170.0 person-years of labor (or $18,194 of capital per person-year of labor) were used to produce a bundle of U.S. imports worth $1 million. Thus, U.S. imports required $4,201 ($18,194 – $13,993) more in capital per person-year of labor to produce than exports did.These results were not consistent with the predictions of the Heckscher-Ohlin theory: U.S. imports were nearly 30 percent more capital-intensive than were U.S. exports. The Heckscher-Ohlin theory made intuitive sense, yet Leontief’s findings were the reverse of what was expected. Thus was born the Leontief paradox.Some scholars argued that Leontief’s measurement system was flawed and could have accounted for his paradoxical results. During the past 50 years, numerous economists have repeated Leontief’s initial study in an attempt to resolve the paradox, but the outcomes have not coincided with those predicted by the Heckscher-Ohlin Theory.
- This section focused on Classical Country-Based Trade Theories. The discussion was supported by a review of the following topics: mercantilism, absolute advantage, comparative advantage, relative factor endowments, and the Leontief Paradox. The next section will review Modern Firm-Based Trade Theories.
- Since World War II, firm-basedtheories have developed for several reasons: (1) the growing importance of MNCs in the postwar international economy; (2) the inability of the country-based theories to explain and predict the existence and growth of intraindustry trade; and (3) the failure of Leontief and other researchers to empirically validate the country-based Heckscher-Ohlin theory. Unlike country-based theories, firm-based theories incorporate factors such as quality, technology, brand names, and customer loyalty into explanations of trade flows. Because firms, not countries, are the agents for international trade, the newer theories explore the firm’s role in promoting exports and imports.
- Product life cycle theory from the field of marketing was modified by Raymond Vernon of the Harvard Business School. According to Vernon’s theory, the international product life cycle consists of three stages:In Stage 1, the new product stage, a firm develops and introduces an innovative product in response to a perceived need in the domestic market. The existence of a profitable market for the product is uncertain, so marketing executives must monitor customer reactions closely. Furthermore, the firm often minimizes its investment in manufacturing capacity for the product, and sells mostly to the domestic market.In Stage 2, the maturing product stage, demand for the product expands dramatically as consumers recognize its value. The innovating firm builds new factories to expand its capacity and satisfy domestic and foreign demand for the product. Domestic and foreign competitors begin to emerge, lured by the prospect of lucrative earnings.In Stage 3, the standardized product stage, the market for the product stabilizes. The product becomes more of a commodity, and firms are pressured to lower their manufacturing costs as much as possible by shifting production to facilities in countries with low labor costs. As a result, the product begins to be imported into the innovating firm’s home market (by either the firm or its competitors). In some cases, imports may result in the complete elimination of domestic production.
- Interindustry trade is the exchange of goods produced by one industry in country A for goods produced by a different industry in country B, such as the exchange of French wines for Japanese clock radios. Yet much international trade consists of intraindustry trade—trade between two countries of goods produced by the same industry.
- In 1961, Swedish economist Steffan Linder sought to explain the phenomenon of intraindustry trade. He hypothesized that international trade in manufactured goods results from similarities of preferences among consumers in countries that are at the same stage of economic development. His country similarity theory suggests that most trade in manufactured goods should be between countries with similar per capita incomes and that intraindustry trade in manufactured goods should be common. Linder’s theory is particularly useful in explaining trade in differentiated goods such as automobiles, expensive electronics equipment, and personal care products, for which brand names and product reputations play an important role in consumer decision making.
- New trade theory was developed in the 1970s and 1980s by Helpman, Krugman, and Lancaster. According to this theory, economies of scale occur if a firm’s average costs of producing a good decrease as output of that good increases. Decreasing average costs can lead to a sustainable competitive advantage in a number of ways: Owning intellectual property rights. A firm that owns an intellectual property right—a trademark, brand name, patent, or copyright—often gains advantages over its competitors.Investing in research and development. R&D is a major component of the total cost of high-technology products. Because of such large “entry” costs, other firms often hesitate to compete against established firms. According to the global strategic rivalry theory, trade flows may be determined by which firms make the necessary R&D expenditures. Thus the firm that acts first often gains a first-mover advantage. Achieving economies of scope. Economies of scope occur when a firm’s average costs decrease as the number of different products it sells increases. These lower costs give the firm a competitive advantage over global rivals.Exploiting the experience curve. For certain types of products, production costs decline as the firm gains more experience in manufacturing the product. Experience curves may be so significant that they govern global competition within an industry.
- Michael Porter’s theory of national competitive advantage blends country based theories with firm-based theories. Porter believes that success in international trade comes from the interaction of four country- and firm-specific elements: Factor conditions. A country’s factors of production affect its ability to compete. Porter goes beyond the basic factors (land, labor, and capital) to include the educational level of the workforce and the quality of the country’s infrastructure. Demand Conditions. The existence of a large, sophisticated consumer base often stimulates the development and distribution of innovative products as firms struggle for dominance in their domestic markets. In meeting their domestic customers’ needs, firms develop and fine-tune products that also can be marketed internationally. Related and supporting industries. The emergence of an industry often stimulates the development of local suppliers eager to meet that industry’s business needs. Competition among input suppliers leads to lower prices, higher-quality products, and technological innovations in the input market, all of which reinforce the industry’s competitive advantage in world markets.Firm strategy, structure, and rivalry. Firms overcome vigorous domestic competition by reducing costs, boosting product quality, raising productivity, and developing innovative products. Firms that have been tested in this way often develop the skills needed to succeed internationally. Further, many of the investments they have made in the domestic market are transferable to international markets.
- This section focused on Modern Firm-Based Trade Theories. The discussion was supported by a review of the following topics: product life-cycle theory, the types of trade, country-similarity theory, new trade theory, and Porter’s theory of national competitive advantage.The next section will provide An Overview of International Investment.
- While trade is the most obvious form of international business, it is not the only form that such business can take. Another major form is international investment, whereby residents of one country supply capital to a second country.
- International investment is divided into two categories: Foreign portfolio investment (FPI) represents passive holdings of securities such as foreign stocks, bonds, or other financial assets. Modern finance theory suggests that foreign portfolio investments will be motivated by attempts to seek an attractive rate of return while reducing the risk that can come from geographically diversifying one’s investment portfolio. Foreign direct investment (FDI) is acquisition of foreign assets for the purpose of controlling them. FDI may take many forms, including purchase of existing assets in a foreign country; new investment in property, plant, and equipment; and participation in a joint venture with a local partner.
- We can gain additional insights by looking at the stock of FDI in the United States, which totaled $2.3 trillion (measured at historical cost) at the end of 2010. The stock of FDI by U.S. residents in foreign countries totaled $3.9 trillion at the end of 2010 Most of this FDI was in other developed countries.
- As this graph shows, outward FDI has remained larger than inward FDI for the United States for over a decade. However, both categories have tripled in size. Even though inward and outward flows of FDI are not perfectly matched, it is clear that most FDI is either made by or destined for the most prosperous countries.
- This section provided An Overview of International Investment. The discussion was supported by a review of the types of international investments, foreign direct investment and the United States, and outward and inward U.S. FDI in billions of dollars. The next section will explore International Investment Theories.
- Two-way investment occurs on an industry basis. This pattern cannot be explained by national or industry differences in rates of return; therefore, we must search for another explanation for Foreign Direct Investment.
- Powerful explanations for FDI focus on the role of the firm. The ownership advantage theory suggests that a firm owning a valuable asset that creates a competitive advantage domestically can use that advantage to penetrate foreign markets through FDI. The asset could be, for example, a superior technology, a well-known brand name, or economies of scale.
- The ownership advantage theory only partly explains why FDI occurs. It does not explain why a firm would choose to enter a foreign market via FDI rather than exploit its ownership advantages internationally through other means, such as exporting its products or licensing technology to foreign firms.Internalization theory addresses this question. In doing so, it relies heavily on the concept of transaction costs. Negotiating, monitoring, and enforcing a contract incur transaction costs. A firm must decide whether it is better to own and operate its own factory overseas or to contract with a foreign firm to do this through a franchising, licensing, or supply agreements. If transaction costs are high, internalization theory suggests that FDI is more likely to occur, so international production will be internalized within the firm. Conversely, internalization theory holds that when transaction costs are low, firms are more likely to contract with outsiders and internationalize by licensing their brand names or franchising their business operations.
- Although internalization theory addresses why firms choose FDI as the mode for entering international markets, the theory ignores the question, “Is there a location advantage to producing abroad?” John Dunning addresses this question in his eclectic theory. Dunning’s theory recognizes that FDI reflects both international business activity and business activity internal to the firm. According to the theory, FDI will occur when three conditions are satisfied:Internalization advantage. The firm must benefit more from controlling the foreign business activity than from hiring an independent local company to provide the service. Location advantage. Undertaking the business activity must be more profitable in a foreign location than undertaking it in a domestic location.Ownership advantage. The firm must own some unique competitive advantage that overcomes the disadvantages of competing with foreign firms on their home markets.
- This section focused on International Investment Theories by reviewing ownership advantages, internalization theory, and Dunning’s eclectic theory. The next section will explore the Factors Influencing Foreign Direct Investment.
- Given the complexity of the global economy and the diversity of opportunities that firms face in different countries, it is not surprising that numerous factors influence a firm’s decision to undertake FDI. They can be classified as supply factors, demand factors, and political factors.
- A number of supply factors can influence a firm’s decision to undertake FDI.Production costs. Firms often undertake FDI to lower production costs. Foreign locations may be attractive because of lower land prices, tax rates, commercial real estate rents, or because of better availability and lower cost of labor.Logistics. If transportation costs are significant, a firm may choose to produce in the foreign market rather than export from domestic factories. International businesses also often make host-country investments to reduce distribution costs.Availability of Natural Resources. Firms may utilize FDI to access natural resources that are critical to their operations. Often international businesses negotiate with host governments to obtain access to raw materials in return for FDI.Access to Key Technology. Another motive for FDI is to gain access to technology. Firms may find it more advantageous to acquire ownership interests in an existing firm than to assemble an in-house group to develop or reproduce an emerging technology.
- A number of demand factors may encourage firms to engage in FDI to expand the market for their products.Customer Access. Many types of international business require firms to have a physical presence in the market. For example, fast-food restaurants and retailers must provide convenient access to their outlets for competitive reasons.Marketing Advantages. The physical presence of a factory can enhance the visibility of a foreign firm’s products in the host market. The foreign firm also gains from “buy local” attitudes of host country consumers. Firms may also engage in FDI to improve customer service.Exploitation of Competitive Advantages. FDI may be a firm’s best means to exploit a competitive advantage that it already enjoys. An owner of a valuable trademark, brand name, or technology may choose to operate in foreign countries rather than export to them. Customer Mobility. A firm’s FDI also may be motivated by its customers or clients. If one of a firm’s existing customers builds a foreign factory, the firm may decide to locate a new facility of its own nearby. Thus, the firm could enhance its level of support for that customer. Equally important, establishing the new factory will reduce the possibility that a competitor in the host country will step in and steal the customer.
- Political factors may also enter into a firm’s decision to undertake FDI. Firms may invest in a foreign country to avoid trade barriers by the host country or to take advantage of economic development incentives offered by the host government.Avoidance of Trade Barriers. Firms often build foreign facilities to avoid trade barriers, such as high tariffs on imported consumer electronics goods. Economic Development Incentives. Most democratically elected governments intend to promote the economic welfare of their citizens. Those governments offer incentives to firms (such as improvements to infrastructure or reduced utility rates) to induce them to locate new facilities and provide jobs in their jurisdictions.
- This section explored the following Factors Influencing Foreign Direct Investment—supply, demand, and political factors. The presentation will close with a review of this chapter’s learning objectives.
- This concludes the PowerPoint presentation on Chapter 6, “International Trade and Investment.” During this presentation, we have accomplished the following learning objectives: Understood the motivation for international trade. Summarized and discussed the differences among the classical country-based theories of international trade. Used the modern firm-based theories of international trade to describe global strategies adopted by businesses. Described and categorized the different forms of international investment.Explained the reasons for foreign direct investment.Summarized how supply, demand, and political factors influence foreign direct investment.For more information about these topics, refer to Chapter 6 in International Business.