Excerpt
Table of contents
Abstract
List of abbreviations
List of figures
List of formulas
1 Increasing protectionism endangers the global wealth
2 Multinational Companies and different types of foreign direct investments
2.1 The role of Multinational Companies in international trade
2.2 Scope and types of foreign direct investments
3 Impact and cause of International Trade explained with the Heckscher-Ohlin Model
3.1 The Heckscher-Ohlin Model
3.2 Impact of international trade based on the HOM
4 Impact of MNC and their FDIs based on different forms of trade policy
4.1 Trade policies and their effect on FDIs
4.2 Impact of FDIs from MNC on foreign countries
5 Summary, Conclusion and Outlook
Bibliography
Abstract
The strong internationalisation of the world economy has led to many multinational companies (MNCs) investing in foreign countries to enter new markets. With this expansive market strategy, foreign direct investments (FDIs) contribute significantly to global international trade. After decades of increasing FDI volume, it has decreased for the past decade due to the renaissance of trade-restrictive measures, which might endanger the global wealth in the future.
The purpose of this seminar paper is to define the role and impact of MNCs activities on international trade and foreign direct investments. The Heckscher-Ohlin model and the resulting theorems are used to explain the cause and effect of international trade. The theorems are discussed and checked for their validity. The influence of different trade policies on the investment behaviour of MNCs will be investigated, as well as the effect of FDIs on the investment countries.
Keywords: Multinational company, MNC, Foreign Direct Investment, FDI, trade policies, Heckscher-Ohlin model, trade, international trade
List of abbreviations
- Cf. Compare
- CRS Constant Return on Scale
- Ed. Editor
- EU European Union
- f. Following page
- ff. Following pages
- FDI Foreign Direct Investment
- GATT General Agreement on Tariffs and Trade
- HOM Heckscher-Ohlin Model
- OLI Ownership Location Internalisation
- M.Sc. Master of Science
- MNC Multinational Company
- N.U. Name Unknown
- OECD Organisation for Economic Cooperation and Development
- p. Page
- USA United States of America
List of figures
Figure 1: Connection and dependencies of supply and demand 2
List of formulas
Formula 1: Total amount of capital and labour in the HOM
Formula 2: Constant returns on scale
Formula 3: Relative Factor Abundance
Formula 4: Relative Factor Intensity
1 Increasing protectionism endangers the global wealth
Companies are forced to permanently increase their efficiency and effectivity in all functional areas to stay competitive.1 In today´s competition, it is almost impossible to avoid the international markets, especially for large enterprises. The strong internationalisation of the global economy over the past decades can be attributed to the increased volume of goods, services and technologies traded internationally.2 There has also been a strong increase in foreign direct investments (FDIs). However, the trend over the last decade has goes in the opposite direction, especially for developed countries.
The General Agreement on Tariffs and Trade (GATT) is intended to provide a basis for free international trade, but an increasing number of national laws and regulations lead to a multitude of trade barriers.3 The growing use of customs and other instruments of protectionism, particularly by the industrialised countries, is one of the central unsolved problems of international trade. These measures aim to preserve national advantages at the expenses of the wealth of the global society.
The main objective of this scientific paper is to define the role of Multinational Companies (MNC) in the international trading system. It is to be shown which effects the contrary trade policies free trade and protectionism have on international trade and the investment behaviour of MNC. The opportunities and risks of FDIs should be identified from the perspective of the MNCs and investment countries.
The scientific paper thesis contains five chapters. Key terms and the relation between MNC and international trade will be defined in chapter two. At the beginning of chapter three, the Heckscher-Ohlin Model will be explained. Then theorems based on this international trade theory will be used to explain the cause and effects of international trade.
In the fourth chapter, the different motives of free trade and protectionism and their effect on FDIs will be examined. The potential chances and risks of FDIs for the investment receiving countries and MNCs are then discussed. In the last chapter, the key findings of this paper are summarized. The paper ends with a conclusion and an outlook, where further significant research needs are addressed.
2 Multinational Companies and different types of foreign direct investments
2.1 The role of Multinational Companies in international trade
In this chapter, the key terms of this scientific paper and their relation will be explained. In economic theory, the Market is defined as the meeting of supply and demand.4 This results in an exchange process in which customers exchange money for goods or services from companies.
Demand is an economic principle that refers to a customers´ desire to purchase goods or services with the willingness to pay a price for them.5 The term Supply can be defined as the total amount of goods or services on the market available. Goods and services can be purchased at a specific price.
In the free market economy, the Price is mainly determined by the prime costs. These include all costs that are required to produce a service object and to put it into a saleable condition.6 Competitors, the own strategy and general market conditions have a big impact on the price as well.
Figure 1: Connection and dependencies of supply and demand
Abbildung in dieser Leseprobe nicht enthalten
Source: Based on Lusted, M. [Supply and Demand 2019] p.25.
Figure 1 shows the close relation between demand and supply. Ideally, demand and supply are in equilibrium, because the customers’ needs can be satisfied and producing company won´t have overstock or backlog.
A changing price is just one of many possible scenarios that could lead a market into disequilibrium. Both the supply and the demand are influenced by so many factors, that there could never be a long period where the market is in equilibrium.7
Trade between two or more parties is done to keep the emerging disequilibrium as small as possible for all participants of the transaction. Therefore, the scope of trading is balancing temporal or permanent tensions between production/supply and consumption/demand.
International Trade is trading across national borders.8 Economic transactions are made between countries. These transactions include products, services and capital/investments and are done between persons, companies, or states. The party that sells is exporting and the party on the receiving end of the transaction is importing.
In the following, the focus will be on companies, that are internationally trading. Those companies belong to the category of MNCs. In this scientific paper, a Multinational Company will be defined as a business that operates in more than one country at the same time and exchanges goods, services and capital across national boundaries.9 Without international trade, countries would be limited to their domestic resources and capital. Therefore, MNC were and still are crucial for the rapid expansion of globalisation of the past decades.
2.2 Scope and types of foreign direct investments
An Investment is the use of capital by an investor for a specific purpose. There are many different classifications of investments. The focus will be on FDIs in this scientific paper because there is an important link between international trade, the way MNC are organised and their direct investments.
Foreign Direct Investment is a category of investment and can be defined as cross-border investment by a domestic investor.10 In this type of investment, the investor has a significant degree of influence on the direct investment object, usually at least a 10% share. Besides capital, often knowledge and technology are also transferred.
The opposite of FDIs is Foreign Indirect Investments, also called Portfolio Investments.11 The Investor is only interested in the profits of foreign companies in the form of high returns on investment. Only capital is used in transactions. These investments may include a long-term interest, but the degree of influence is low (<10% share).
In this paper, the focus will be on FDIs from MNC exclusively. The emergence of an MNC requires foreign investments.12 Almost the complete global FDI volume is caused by these companies.
Before companies decide to invest in foreign countries they must evaluate if the investment will be beneficial for them or not. Furthermore, they need to decide in which country they invest, and which form of investment they want to use. Based on the Eclectic Paradigm of John Dunning FDIs are done when O wnership, L ocation, and I nternalisation Advantages (OLI) are sufficient.
Ownership Advantages: The company needs to have enough assets to cover up with costs incurred during the market entry.13 These assets or competitive advantages could be internal company know-how, high reputation, or high reliability for example.
Location Advantages: This paradigm determines in which country a company should invest with their Ownership Advantages. The following factors are particularly important for the selection of the country:14
- Economic Advantages: Labour costs, transportation costs
- Political Advantages: Trade policy of the foreign country15
- Social Advantages: Culture diversity, acceptance of foreign companies
Internalisation Advantages: Once the company decided in which country, they want to invest with their Location Advantages, it needs to be decided whether they want to build up an own production, use foreign production capacities or a mixture of both.16
Based on this theory FDIs are made when all three advantages (OLI) are present.17 If there are no Location Advantages, a company should stick to domestic production and export their goods. If there are only Ownership Advantages a company should try to maximise their profits by handing out licenses to foreign companies.
Regardless of whether it is a relationship with direct investment enterprise or the establishment of an own organisation/facilities abroad, the motivation of FDI is a strategic long-term benefit of the investment.18
In general, FDIs of MNC can be divided into four different categories, each with different scopes and motives:
Demand oriented FDIs have market-seeking motives. The MNC aims to gain access to new markets by satisfying a foreign market, following key customers, or competing with rivals in their domestic market.19
Supply oriented FDIs have resource-seeking motives.20 The MNC aims to access raw materials or technological and managerial know-how of the foreign market. The extractive and agricultural sector relies heavily on raw materials in foreign countries. Accessing technological know-how is often done by participating in a cluster.
Rationalised FDIs have efficiency-seeking motives.21 The MNC aims to increase efficiency by reducing their costs in all functional areas. The production costs are often reduced by lower personal costs and other production inputs. Transportation/sourcing costs can be reduced by locating near customers/suppliers. To locate near customers can also have the benefit of avoiding trade barriers if the goods are produced in the target market.
Strategic FDIs have strategic-asset-seeking motives. The MNC aims to at least keep their position on the competitive market.22 This is done by investing in objects, that protect or even improve the Ownership Advantages of the own company and/or reduce those of their competitors.
3 Impact and cause of International Trade explained with the Heckscher-Ohlin Model
3.1 The Heckscher-Ohlin Model
International trade theory is a field of economic sciences, which analyses the reason for and the impact of international trade on the involved parties.23 Almost all international trade theories are based on two basic models of international trade – the Ricardian Model and the Heckscher-Ohlin Model.
The Ricardian Model is named after David Ricardo, who invented the theory in 1817.24 It explains foreign trade between two countries that both manufacture the same two products. The basic assumption is the existence of different labour productivity that leads to different opportunity costs. If both countries specialise according to their comparative advantage, they both can benefit from the trade. The comparative advantage is the ability of a country to make a product at lower opportunity costs than the other country.
The Heckscher-Ohlin model (HOM) also known as the factor-proportions theory was invented in the 1920s and 1930s by Eli Heckscher and Bertil Ohlin. It is still one of the most important models of international trade theory and serves as the basis for many modern models of trade theory.25 Like Ricardo, Heckscher and Ohlin assumed a comparative advantage and showed the advantage of foreign trade. However, they attributed the comparative advantage to differences in factor endowments of the countries.
Compared to the Ricardian Model, the most important change is the addition of a second factor of production. In its simplest form, which will be used in this chapter, it describes the exchange of goods between two countries, producing the same two products with two primary factors of production.
Following assumptions are made in the HOM26:
- Two countries produce the same two goods with the same two factors of production -labour and capital.
- Both countries have the same technological progress in production. The same input is needed to produce one unit regardless of which country.
- The total amount of labour and capital used in production is limited to the endowment of the country, see Formula 1.
Formula 1: Total amount of capital and labour in the HOM
Abbildung in dieser Leseprobe nicht enthalten
Source: Based on Suranovic, S. [International Trade 2010] p. 62.
- There is complete factor mobility in the labour market, that equalizes the wage and rental rate across sectors. All production areas are always fully employed.27
- Although the production factors are mobile, there is an incomplete specialization in production. Therefore, both countries produce both products.28
- There is free trade between the countries. All outputs can be traded without any restrictions, but labour and capital do not move between countries.
- There is perfect competition in the market. Companies can freely enter and exit the market. The economic profit among competitors is zero. In the long run, the marginal costs and the average costs are the same.
- The model assumes constant returns on scale (CRS). When the input of a product is increased, the output increases always at the same ratio.
Formula 2: Constant returns on scale
Abbildung in dieser Leseprobe nicht enthalten
Source: Based on Kirilyuk, I., Senko, O. [Returns on Scale 2019] p.2.
- The consumer tastes are identically in both countries for both products and do not change with the country´s level of income. The products are consumed at the same ratio.
[...]
1 Cf. Haaker, O. [Location Selection of MNC 2015] p.1f.
2 Cf. Zhan, J. [World Investment Report 2019] p.15f.
3 Cf. Büter, C. [International Trade Relations 2017] p.22f.
4 Cf. Kleinaltenkamp, M., Kuß, A. [Marketing 2013] p.27f.
5 Cf. Moon, M. [Demand and Supply Integration 2018] p.20f.
6 Cf. HERING, E. [Cost Management 2015] p.10.
7 Cf. Lusted, M. [Supply and Demand 2019] p.25f.
8 Cf. Gandolfo, G. [International Trade Theory 2014] p.161.
9 Cf. Dunning, J., Lundan, S. [Multinational Enterprises 2008] p.5f.
10 Cf. Strauss-Kahn, D. [International Investment Position 2009] p.100.
11 Cf. Sauvant, K. [FDI Policies 2003] p.100.
12 Cf. Broll, U. [Foreign Trade and Investment 1995] p.200.
13 Cf. Filippaios, F., Stoian, C. [Determinants of outward FDI 2008] p.354.
14 Cf. Dunning, J., Lundan, S. [Multinational Enterprises 2008] p.138.
15 See Chapter 4.1.
16 Cf. Zhu, B. [Internalisation of Chinese MNC 2008] p.21.
17 Cf. Kutschker, M., Schmid, S. [International Management 2011] p.462.
18 Cf. N.U. [OECD Benchmark Definition of FDI 2008] p.17.
19 Cf. Dunning, J. [International Production Motives 2015] p.63.
20 Cf. Haaker, O. [Location Selection of MNC 2015] p.27.
21 Cf. Rugman, A. [Internalisation Theory 2010] p. 7f.
22 Cf. Zhu, B. [Internalisation of Chinese MNC 2008] p.23f.
23 Cf. Davidson, C., Matusz, S. [Trade and Labor Markets 2004] p.2.
24 Cf. Suranovic, S. [International Trade 2010] p. 62.
25 Cf. Gandolfo, G. [International Trade Theory 2014] p.63.
26 Cf. Krugman, P., Obstfeld, M. [International Economics 2003] p.68ff.
27 Cf. Davidson, C., Matusz, S. [Trade and Labor Markets 2004] p.2.
28 Cf. Krugman, P., Obstfeld, M. [International Economics 2003] p.68ff.
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