International EconomicsBy Robert J. Carbaugh

8th Edition

Chapter 10:

International Factor Movements and Multinational Enterprises

Factor movements & multinational enterprises

Multinational enterprises

• Various business operations in numerous host countries

• Headquarters often far from operations• Stock ownership and management are

multi-national• Frequently employ vertical integration,

horizontal integration, conglomerate structure

Multinational enterprises

Foreign direct investment

• A foreign or multinational firm can buy a controlling interest in a local firm

• Buy or build new plants or equipment overseas

• Shift funds abroad to expand a subsidiary

• Reinvest the earnings of a foreign subsidiary

Multinational enterprises

Reasons for foreign direct investment

• Demand factors– Serve different local markets– Respond to market competition

• Cost factors– Access to key raw materials– Labor costs– Transportation costs– Government policies

Choice between export and FDIForeign direct investment

Choice between licensing and FDIForeign direct investment

Multinational enterprises

International joint ventures

• Two companies can operate a venture in a third country

• A foreign firm can work with a local company

• A foreign firm can form a venture with a unit of the local government

Multinational enterprises

Reasons for international JVs

• Cost sharing - R&D, capital expenditures (in mining and oil, for example)

• Avoiding restrictions on foreign ownership of local firms (ensuring local participation)

• Forestalling pressure for protectionism• Problems: divided control means success of

JV depends on ability of firms to work together

Effects of an international JVMultinational enterprises

Multinational enterprises

Controversy over multinationals

• Employment– Host country may not gain many jobs, foreign

managers often brought in; source country worries about losing jobs

• Technology transfer– MNEs are reluctant to share technology with

host nations; source country worries about giving away advantage

Multinational enterprises

Controversy over multinationals (Cont’d)

• National sovereignty– Host country worries about power of MNE to

influence affairs; source country worries about ability to regulate MNE activities elsewhere

• Balance of payments– MNE investments and profits (internal

transfers) have impacts on the payments status of both source and host nations

Multinational enterprises

Controversy over multinationals (Cont’d)

• Taxation– Source countries may have difficulty taxing

MNE income stemming from foreign operations

• Transfer pricing– Both host and source governments worry that

MNEs may illegally manipulate prices paid between subsidiaries to avoid taxes

Transfer pricing illustrated

Multinational enterprises

Germany(tax rate 48%)

Computer produced by

parent firm for $2000. Sold to Irish subsidiary

for $2000.

German tax paid: $0.

Ireland(tax rate 4%)

Irish subsidiary resells the same computer to US subsidiary for

$2500, earning $500 profit.

Irish tax paid: $20.

United States(tax rate 34%)

US subsidiary sells computer at cost,

for $2500. No profit is earned.

US tax paid: $0. Irish subsidiary

then lends money to US subsidiary

for expansion

International factor movements

Migration

• Tends to equalize wage rates between countries

• Shifts distribution of income between capital and labor

• Other concerns:– Fiscal drain from immigration– Brain drain from developing countries– Status of temporary guest workers