WEEK 2: International Trade, Foreign Direct Investment

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WEEK 2 International Trade, Foreign Direct
Investment

• Intl Business
• Berkeley City College - Spring 2007

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• 1st British African colony to win independence
  (1957).
• High tariffs.
• Anti-exporting policy.

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• Kept lowering tariffs on manufactured goods.
• Created incentives to export.
• Reduced quotas.
• Reduced subsidies.
• 1950s 77 of employment in agriculture. Now 20.
• Manufacturing GNP went from 10 to over 30.

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The Impact of Trade Policies

• Ghana
• 1970
• GNP/capita
• 250
• 1992
• GNP/per capita
• 450
• GNP Growth/year
• 1.5
• Shift from productive uses (cocoa) to
  unproductive uses
  (subsistence agriculture).

• Korea
• 1970
• GNP/per capita
• 260
• 1992
• GNP/per capita
• 6790
• GNP Growth/year
• 9
• Shift from non-comparative advantage uses
  (agriculture) to productive uses (labor-intensive
  manufacturing).

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What is International Trade?

• Trade is an exchange of goods and services.
• Exports are domestically-produced goods and
  services purchased by foreigners.
• Imports are foreign-produced goods and services
  purchased by domestic residents.

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An Overview of Trade Theory

• Free Trade occurs when a government does not
  attempt to influence, through quotas or duties,
  what its citizens can buy from another country or
  what they can produce and sell to another
  country.
• The Benefits of Trade allow a country to
  specialize in the manufacture and export of
  products that can be produced most efficiently in
  that country.
• The Pattern of International Trade displays
  patterns that are easy to understand (Saudi
  Arabia/oil or China/crawfish). Others are not so
  easy to understand (Japan and cars).
• The history of Trade Theory and Government
  Involvement presents a mixed case for the role of
  government in promoting exports and limiting
  imports. Later theories appear to make a case
  for limited involvement.

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Theories of Intl Trade

• Mercantilism
• Absolute Advantage
• Comparative Advantage
• Heckscher-Ohlin Model Factor Endowments
• Porters Diamond
• Product Life Cycle

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Theory 1 Mercantilism

• An economic philosophy based on the belief that
• a nations wealth depends on accumulated
  treasure, usually gold, and
• to increase wealth, government policies should
  promote exports and discourage imports.

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2 Theory of Absolute Advantage

• Adam Smith Wealth of Nations (1776).
• Capability of one country to produce more of a
  product with the same amount of input
  than another country.
• Produce only goods where you are most efficient,
  trade for those where you are not efficient.
• Trade between countries is,
  therefore, beneficial.
• Assumes there is an
  absolute advantage
  balance among
  nations.
• Ghana/cocoa.

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3 Theory of Comparative Advantage

• Comparative Advantage
• A nation has a comparative advantage in producing
  the good in which its absolute disadvantage is
  less.
• Theory of comparative advantage was demonstrated
  by Ricardo in 1817.

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4 Heckscher-Ohlin Theory of Factor Endowment

• Factor Endowment Heckscher-Ohlin theory indicates
  that countries export products requiring large
  amounts of their abundant production factors
  import products requiring large amounts of their
  scarce production factors
• China should export labor intensive goods.
• Netherlands, with relatively more capital than
  labor should specialize in capital intensive
  products.

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5 Porters DiamondDeterminants of National
Competitive Advantage
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6 International Product Life Cycle

• IPLC is a theory explaining why a product that
  begins as a nations export eventually becomes
  its import.
• Four stages of the IPLC in the United States
• 1) U.S. exports
• 2) Foreign production begins
• 3) Foreign competition in export markets
• 4) Import competition in the U.S.

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The 7 Instruments of Trade Policy
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Tariffs
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Subsidies
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Import Quotas and Voluntary Export Restraints
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Add Valorem Tariff Quota
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Local Content Requirements (LCR)
Widely used by developing countries to develop
their manufacturing base.
A specific fraction of a good must be
domestically produced.
A specific fraction of a good must be
domestically produced.
Used by developed countries to protect local
jobs and industry from foreign competition.
Physical amount
Value
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Administrative Policies

• Bureaucratic rules designed to make it difficult
  for imports to enter a country.
• Japanese masters in imposing rules.
• Tulip bulbs.
• Federal Express.

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Antidumping Policies

• Selling goods into a foreign market below
  production costs, or
• Selling below fair market value.
• Used to unload excess production.
• Or, predatory pricing.
• Antidumping policies are used to punish foreign
  firms.
• Protect local industry from unfair practices.
• Impose countervailing duties.

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Political Arguments for Intervention
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Economic Arguments for Intervention
? Infant industry is the oldest economic
argument for government intervention, dating
to 1792 and Alexander Hamilton. ? Protect
developing countrys new industry from
developed countries better established
industries. Recognized by GATT. ? Strategic
trade policy can help a firm gain first
mover advantages or overcome barriers
created by a different (foreign) first mover.
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Development of the World Trade System World War
I to World War II1918 - 1939

• Great Depression
• US stock market collapse
• Smoot-Hawley Act (1930)
• US had positive trade balance with world
• Act imposes tariffs to protect U.S. firms.
• Foreign response was to impose own barriers
• US exports tumbled

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General Agreement on Tariffs and Trade

• WWII allies want international organization in
  trade arena similar to UN in political arena.
• GATT proposed by US in 1947 as step toward ITO.
• 1948 Havana Conference.
• Failed charter for the International Trade
  Organization.
• GATT
• 19 original members grew to 120 nations by the
  time it was superceded by the WTO. Today 148
  nations.
• GATT members agree not to raise tariffs above
  negotiated rates.

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Average Reduction in US Tariff Rates 1947 - 85
Index Pre-Geneva Tariff 100
GATT Negotiating Rounds
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World Trade Organization

• Umbrella organization for
• GATT
• Services
• Intellectual property
• Responsibility for trade arbitration
• Reports adopted unless specifically rejected.
• After appeal, fail to comply can result in
  compensation to injured country or trade
  sanctions.

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Foreign Direct Investment
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Starbucks

• Starbucks strategy
• Coffee house setting, blended coffees
• Superior customer service
• Attention to hiring, training, and compensation
• Motivation of employees
• Used nation-specific strategies
• Britain
• Japan
• Thailand
• Korea

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Foreign Direct Investment

• FDI occurs when a firm invests directly in
  facilities to produce and/or market a product in
  a foreign country.
• Once a firm undertakes FDI, it becomes a
  multinational enterprise.
• FDI takes two forms
• Green-field investment establishing a wholly new
  operation in a foreign country.
• Acquiring or merging with an existing firm in the
  foreign country.
• Investing in foreign financial instruments
  (Portfolio Investment) IS NOT FDI.

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FDI Outflows, 1982-2004

• Flow - the amount of FDI undertaken over a given
  period of time (usually 1 year).

• Stock - total accumulated value of foreign-owned
  assets at a given time.

in Billions of
Figure 7.1, p. 240
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FDI Flows Developed vs. Developing Countries
in Billions of
Figure 7.2, p. 241
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Reasons for FDI Growth

• FDI circumvents potential future trade barriers.
• Dramatic political and economic changes occurring
  in developing countries.

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The Form of FDI Acquisitions versus Green-Fields

• The majority of investments is in the form of
  mergers acquisitions
• Represents about 77 of all flows in developed
  countries.
• Represent about 33 of all flows in developing
  countries.
• Fewer target firms.

• Why the preference for mergers acquisitions?
• Quicker to execute.
• Foreign firms have valuable strategic assets.
• Believe they can increase the efficiency of the
  acquired firm.

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FDI and Risk

• FDI is expensive and risky compared to exporting
  or
• licensing
• Costs of establishing facilities
• Problems with doing business in a different
  country
• Culture
• Horizontal Direct Investment FDI in the same
  industry as the firm operates at home.
• Factors to consider
• Transportation Costs
• Market Imperfections
• Following Competitors
• Strategic Competitors
• Location Advantages

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Horizontal FDI and Factor Considerations
Transportation Costs High/low value to weight
impacts costs. Market Imperfections
(Internalization Theory) Factors that inhibit
markets from working perfectly. This includes
(1) governments impeding the free flow
of products between nations, and (2) impediments
to the sale of know-how. Strategic Behavior
Concentrated industries (oligopoly) tend to
mimic each others moves. Where there is
multipoint competition, competing firms match
each others moves to keep the competitor in
check.
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Horizontal FDI and Factor Considerations
The Product Life Cycle Suggests that foreign
market demand leads to FDI, probably not true
and therefore is not a good predictor of FDI.
Location-Specific Advantages Advantages that
arise from using resource endowments or assets
tied to a particular location
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Vertical FDI

• Two forms
• Backward Providing inputs (raw materials, parts)
  for a firms domestic production processes.
• Forward An industry abroad sells the outputs of
  the firms domestic production processes.

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Impediments to the Sale of Know-how
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A Decision Framework
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Three main ideological positionsregarding FDI
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The Nature of Negotiation

• Objective reach an agreement
  that benefits both parties
• In the international context, we must
• understand the influence of norms and value
  systems
• Be sensitive to how these factors influence a
  companys approach to negotiations

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The Four Cs of Negotiation