MGT 4230 - EXAM 2 (chapters 6-9) (Chapter 6: TRADE THEORY)

Introductiono International Trade Theory:

explains why it is beneficial for countries to engage in international trade

helps countries formulate their economic policy explains the pattern of international trade in the world economy

Tradeo Free trade: refers to a situation where 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

Absence of any government in trade Free trade to economists is like zero gravity to physicists Probably no country that has ever been completely free It’s the most efficient way to allocate scarce resources This differs from “fair trade” or “managed trade”

Fair Trade: (a hot topic in regards to China) Managed Trade: assumes a government’s role but the

government helps its firms Idea with trade exports & imports

o Trade Deficit: when what a country imports from other countries is greater than what a country exports to other countries

Buys > Sells OR Imports > Exports Largest trade deficit = U.S.

In 2016: -$502 billion deficit If our dollar is strong, it makes the foreign things we buy

cheaper and our things more expensive In 2017: -$566 billion deficit (largest since the great recession

in 2008)o (with China & Mexico)

The last year U.S. had a trade surplus was 1975o Trade Surplus: when what a country exports to other countries is greater

than what a country imports from other countries

Sells > Buys OR Exports > Imports Countries doing well with trade surplus: Japan, Iran, South Korea,

Germany (German wage rates are the highest in the world. They

specialize in more sophisticated, high technology)

o Saudi Arabia imports oil (in Louisiana)o Germany imports for BMW (in S.C.)

U.S. Trade: Exports…

o 1. Canadao 2. Mexicoo 3. Chinao 4. Japano 5. UK

o 6. Germanyo 7. S. Koreao 8. Netherlandso 9. Brazilo 10. Hong Kongo 11. Belgiumo 12. Franceo 13. Singaporeo 14. Australiao 15. Taiwano General similarity among 13 of these countries…

Democracies Developed countries (Brazil & China aren’t but they are developing)

U.S. Trade: Export Products…o 1. Machinery, nuclear reactors, boilers, etc.o 2. Electrical, electronic equipmento 3. Mineral fuels, oils, distillation products, etc.o 4. Vehicles other than railway, tramwayo 5. Aircraft, spacecraft, and parts thereofo 6. Optical, photo, technical, medical, etc. apparatuso 7. Pearls, precious stones, metals, coins, etc.o 8. Plastics and articles thereofo 9. Organic chemicalso 10. Commodities not elsewhere specifiedo 11. Pharmaceutical productso 12. Miscellaneous chemical productso 13. Oil seed, oleagic fruits, grain, seed, fruit, etc.o 14. Articles of iron or steelo 15. Cereals

U.S. Trade: Imports…o 1. Chinao 2. Canadao 3. Mexicoo 4. Japano 5. Germany

o 6. South Koreao 7. UKo 8. Saudi Arabiao 9. Franceo 10. Indiao 11. Italyo 12. Taiwano 13. Irelando 14. Venezuelao 15. Switzerland

U.S. Trade: Import Products…o 1. Mineral fuels, oils, distillation products, etc.o 2. Machinery, nuclear reactors, boilers, etc.o 3. Electrical, electronic equipmento 4. Vehicles other than railway, tramwayo 5. Optical, photo, technical, medical, etc. apparatuso 6. Commodities not elsewhere specifiedo 7. Pearls, precious stones, metals, coins, etco 8. Pharmaceutical productso 9. Organic chemicalso 10. Furniture, lighting, signs, prefabricated buildingso 11. Plastics and articles thereofo 12. Articles of apparel, accessories, knit or crocheto 13. Articles of apparel, accessories, not knit or crocheto 14. Articles of iron or steelo 15. Aircraft, spacecraft, and parts thereof

U.S. has a lot of the categories that we both sell & buy (same products or overlap) Trade theories are either country-based or firm-based…

o Country-Based Theories: Mercantilism, 1.)Absolute Advantage, 2.)Comparative Advantage, 3.)Relative Factor Endowments, 4.)Linder’s Overlapping Product Ranges, & 5.)International Product Life Cycle

o Firm-Based Theories: 1.)New Trade Theory, 2.)Diamond Model, & 3.)Rugman Verbeke

Country-Based Theories… o All country-based theories (excluding mercantilism) are also cost-based***o Mercantilism:

Not really a theory. More of a philosophy or theology Prosperity measured by holdings of bouillon Maximize exports; minimize imports through trade barriers Basis for current protectionist sentiments The most anti-free trade policy

Government is VERY involvedo Classical Theories of Trade…

1.) Absolute Advantage: Developed by Adam Smith Countries should specialize Absolute advantage are the roots of modern economic

thinking Focused on exporting products in which the country is more

productiveo (Focus on products with absolute advantage)

Idea: What can we produce MORE of? What if the country has an absolute advantage in both

products? 2.) Comparative Advantage:

Developed by David Ricardo Focus on products in which the country has a relative

advantage In order to comparative advantage, there is always an

opportunity to tradeo Without trade, each country must consume what it

produceso By engaging in trade, two countries can increase their

combined production of their specialized products, and consumers in both nations can consume more of both goods

Incorporates opportunity cost & production possibilitieso (When a country produces a good or services for a lower

opportunity cost that other countries) Problem…

o It doesn’t address sources of advantageo it doesn’t completely explain why some companies do

well and others don’t

Ex: Guns vs. Butter Model…

o First curve= Production Possibility Curve…

Represents all combinations of guns and butter that a country can produce

Second curve= Consumption Possibility Curve… Represents opportunity costs of what has to

be given up to produce either of the 2 (guns or butter)

Y-axis= Guns… Use all of the country’s resources to

produce guns X-axis= Butter…

Use all of country’s resources to produce butter

o 3.) Relative Factor Endowments: Developed by Heckscher & Ohlin Based on two propositions…

1. Country factor endowments vary 2. Different goods require different factors

Focus on producing goods that use abundant factors most intensively A country should focus on products that use their resources

best & export or import products for which they don’t have resources for***

o U.S. exports capital intensive productso U.S. imports labor intensive products

Was not supported by Leontieff (Leontieff Paradox)

(U.S. was importing capital intensive products & exporting labor intensive products)

o 4.) Linder’s Overlapping Product Ranges: Based on demand for manufactured goods Income determines product sophistication Trade occurs between countries of similar income levels

o 5.) International Product Life Cycle: Developed by Vernon International product life cycle has three phases…

1. New product (mostly domestic or at home) 2. Mature product (export oriented) 3. Standardized product (import emphasis)

1st section= Phase I: Innovation

o new product (mostly domestic) 2nd & 3rd section= Phase II: Rapid Growth/Sales

o mature product (export oriented) 4th section= Phase III: Product Dies Down

o standardized product (import emphasis) (There are no TVs in America today that were made in the U.S.) Problem…

If product starts at home, it’s not always going to be just at home during phase 1

Summary of Country-Based Theorieso Country focus does not explain intra-industry tradeo Country focus does not explain the relative success of firms within a

countryo As a result, firm-based theories have been developedo (As we see the deficiencies of county-based theories, we shift towards firm-

based theories)*** Firm-Based Theories…

o 1.) New Trade Theory: Rivalry: (The only pure firm-based theory) Based on strategy of firm & competitive advantage

Focuses on intra-industry trade and firm strategy Competitive advantages in the marketplace explain trade

o Sources of competitive advantage include: first mover advantages, R&D, intellectual property, economies of scope & scale, experience

o 2.) The Diamond Model: Developed by Porter (Competitive advantage in the home country: If a firm comes out of

this model in the home country, they will be more successful in competing)

Competitive advantage is determined by the interplay of…

Factor Conditions: o Deals with the quality and abundance of resources

Large labor force? Skills? Sophisticated financial markets?

Plant? Equipment?o (land, labor, and capital)

Demand Conditions: o Market base= consumers

How sophisticated are the consumers? Do consumers have high expectations? Are they

being met? Do they have good purchasing power?

Related & Supporting Industries: o Deals with inputs

INNOVATION

Infrastructure, communication Firm Strategy, Structure, & Rivalry:

o Deals with the degree of competitiono High rivalry fine tune the strategy and organizations

structure Innovation:

o Innovation is key***o innovation drives a business

Chance and government play a role:o Resource based and refinement government plays a

huge role in theseo There are anti-trust laws to ensure rivalry

(these boxes in the model drive the firm to do new things (innovation))

o 3.) Rugman-Verbeke: Two types of advantages…

1. Firm specific (caliber of labor, quality of products, marketing, distribution, production, etc.)

o if firm does well, it contributes to firm’s performance 2. Country specific (economic, government, etc.)

o government policy with regard to taxes, investments, etc.

The most effective MNC strategies are based on linking the advantages and adjustment

Trade and Policyo While the theories all suggest that trade is beneficial, they lack agreement

for government policy… Mercantilism makes a case for government involvement in

promoting exports and limiting imports Mercantilism is most anti-free trade policy (government is

VERY involved) Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade

(most economist’s perfect scenario: unrestricted free trade) New trade theory and Porter justify limited and selective government

intervention to support the development of certain export-oriented industries

“companies that have potential” assist the company in order to stimulate its growth

Improving Trade Positionso Seek to open foreign markets

Government’s responsibility seek to opening foreign marketso Managers must develop a global orientation

Manager’s responsibility global outlooko Focus on competitive advantage factors: labor costs, interest rates,

exchange rates, economies of scale, productivity, infrastructure, & innovation

Both Government’s & Manager’s responsibilities Implications for Managers…

o 1.) Location Economies: disperse productive activities to those countries where activities can be performed most efficiently

want cheaper labor costs and most efficiency Network affiliated

o 2.) First-Mover: establishing a first-mover advantage in the production of a new product may later dominate global trade in that product

Engage in research and development, translate that into products, & market and distribute products effectively

(Chapter 7: TRADE POLICY) EU-US and Beef

o 1989 - EU bans growth hormone treated beef U.S. exports decline U.S. files complaint to WTO (files with other countries)

o 1998 – U.S. wins WTO Panel declares EU ban to be illegal EU is appeals (reluctant to comply) EU loses the appeal

o 1999 – U.S. raises tariffs on EU products (U.S. raises tariffs in retaliation) U.S. Targets EU by raising tariffs specifically on…

Beef

Pork Sausages Corned Beef Roquefort Cheese Chocolate Products Mustards Chewing Gum Soups and Broths Truffles Mineral Water Cut Flowers Yarn Electric Hair Clippers Motorcycles and Mopeds

This retaliation was designed to spread the hurt and hit a wide array of European countries (different products affected different countries in the EU

Ex: yarnUK, sausagesGermany, etc.o Issues…

Subsidies in agriculture (MAJOR ISSUE) U.S. subsidizes agriculture heavily (agriculture is always at the forefront of trade disputes)

Intellectual property rights Also at forefront in trade discussions

(Free trade is the most efficient way to allocate scarce resources) Questions of Trade…***

o Should government protect domestic firms at home?o Should government assist domestic firms abroad?

Hard power: use of military force, coercion, and intimidation of a country to influence others to do what is wanted

o Mostly military o Can be economics in the sense that…Economics can coerce countries

with sanctions Soft power: ability of a country to persuade others to do what is wanted without

force or coercion o Economics can “woo” a country with wealth

Political Arguments for Intervention…

o (talking about when the government intervenes in the market)o Protecting jobs and industries:

Need to protect jobs in U.S. from cheap foreign labor Cheaper labor is a basis for a competitive advantage Economists have the most trouble with this idea. (cheap

foreign labor argument) o (completely contradictive to idea of free markets)

Need to restrict tradeo National security:

Defense industries (most obvious) – semiconductors Ex: don’t want to rely on foreign companies to make military

weaponso Retaliation:

We raised tariffs on Chinese products, they responded Ex: currently with the Chinese with the Trump Administration

o Protecting consumers: Safety issues with consumers

Ex: we have many restrictions on foreign pharmaceuticals entering the U.S.

o Furthering foreign policy objectives: Helms-Burton Act

(Cuba specifically) Try to get change in government, deter nuclear development, etc.

o Protecting human rights: (Self-explanatory)

Cheap Foreign Labor: market’s resources are distributed differently and specialize according to comparative advantage

o Best way for trade when countries trade their products with a comparative advantage

Economic Arguments for Intervention…o (talking about when the government intervenes in the market)o (because it is economic, doesn’t mean economists are always on board with

it)o Infant industry:

Oldest argument - Alexander Hamilton, 1792 Protect yourself (tariffs, quotas, etc.)

How can a fledgling country (like U.S.) & it’s companies compete among its world powers?

Protected under the WTO Only good if it makes the industry efficient and makes its firms better

(it typically doesn’t do this) Brazil auto-makers - 10th largest - wilted when protection

eliminated. Competition was the driver in their innovation and when their

protection was eliminated, (their barriers that they erected were removed) development was stagnated. Other auto-making companies grew and Brazil auto-makers could no longer compete

Requires government financial assistance (Indirect or direct) If these companies (new or old) are a good investment, global

capital markets would investo The markets are more likely to pick the “race horses”,

government can pick the “mules” (markets will always be better at picking winners

than the government)*** Markets are better at assessing risk, make

judgements about companies, etc.o Just need to give the companies a good start

Principle concern: it doesn’t work most of the time in terms of helping those new firms in new industries

Old industries can use infant industry policies Issue: When does the industry grow up?

o Strategic trade policy: (based upon new trade theory) Government helps raise national income if first-mover advantage is

successful Government intervention may help domestic firms overcome first-

mover advantage of foreign firms Help the firm catch up Ex: Solar Energy. Although technology of it was pioneered in

U.S., we have fallen behind. (if other countries halted, it would take America 5 years to catch up) Say maybe, we need to

protect the solar companies in the U.S. to make up for lost time compared to Japanese and Chinese (who are farther ahead of us).

^^These above bullets are high impact (Anything that is spent, will return in pay-off over time, with success)

We are talking about an industrial policy (mostly done with subsidies, but can be done in other ways…tax breaks, etc.)

Japan and others make decisions based off of MITI (Ministry of International Trade and Industry)

Corporate Welfare: U.S. make decisions based on political favoritism (lobbying campaigns) instead of based on the market (market logic)

o Argument: If we are going to do it, we might as well be honest, do it strategically, and be straightforward

Questions About Trade Policy…o 1.) Should we assist our companies in global markets to make them more

competitive? o 2.) How can a fledgling country (like the U.S.) & it’s companies compete

among its world powers? Instruments of Trade Policy…

o 1.) Tariffs: Tariff: a tax on an imported good The oldest form of trade policy Tariffs can take 2 forms… (specific or ad valorem)

Specific Tariff: a set amounto Car ex: tariff $2,000 per car being imported from

Germany Issue: tariff is the same amount no matter the

price of car. Same tariff amount ($2,000) whether it’s a $20,000 car imported or a $120,000 car imported.

(unequal impact depending on what the value is) Ad Valorem Tariff: pay taxes based on the value of the product

o ex: property taxes in the U.S., tariff U.S. has on steel, etc.o Car ex: tariff is 3% of the value of your car

more expensive car will have higher tariff

$120,000 imported car has a higher tariff than $20,000 imported car

Compound tariff: both specific & ad valorem forms of tariffso Car ex: $2,000 (specific tariff) + 3% of the value of your

car (ad valorem tariff) Good for the government

Tariff $$ goes towards U.S. government Good for domestic producers

(makes consumers buy domestic products rather than foreign) But reduces efficiency Less incentive to keep prices down because competitors are

more expensive Bad for consumers

Paying more for foreign AND domestic productso Ex: They make German cars and American cars more

expensive in the U.S. (because of less incentive to keep prices down since competitors are more expensive)

Can influence investment Investment directly influences job creation Direct impact on jobs***

“Tariff Effects on SC” Article: “Trade dispute we have with China could go on for 20 years” Key: We export a lot from S.C. to Mexico and Canada.

Represents $6.2 billion of the S.C. economy. We (S.C.) are most susceptible to trade wars. 1 of the top 10 states that would be adversely effected if NAFTA were to implode.

o With NAFTA we have more access to Mexican markets. It has been helpful with all parties because it allowed us to become more competitive at a time where other countries like China could have disrupted.

o If NAFTA implodes…small firms would be hit. 8 out of 10 firms who export from S.C. are small firms

BMWo In mexicoo in greer: an investment of 8 billion$

3 major investments, including initial investment, that has expanded the capacity at BMW

What do you do?o Invest in educationo It’s not just about the cost for consumers. With

investment, there can be a direct impact on jobs Antidumping Policies:

Dumping: Either selling goods in a foreign market at below production costs or below fair market value

o Dumping results in either excess production or predatory behavior

Predatory behavior: sacrifice profits today in order to gain a major market share to pay it off in the future

We have antitrust laws that make predatory pricing illegal in the U.S.

Remedy seek imposition of tariffs (countervailing duties)o Countervailing duties: offset the amount below fair

market value (FMV) Ex: say foreign companies were exporting steel

into the U.S. at below fair market value (dumping). U.S.’s duty would then be to add a 30% tariff to the steel to make companies more competitive.

A special kind of tariff for a specific situationo (When you hear about trade policies…they are either tariff or non-tariff

barriers)o 2.) Non-Tariff Barriers:

(quotas or administrative policies) Quotas: a quantity restriction on an import (imposed or voluntary)

Ex: Japanese Trade Carriers… o Imposed Restriction: “U.S. says Japan can send 900 cars

at any point during the year and that is it”o Voluntary Restriction: “If the Japanese are offered a

restriction on exports (900 cars), they could offer a better deal than whatever the U.S. would impose”

(if you volunteer, you might get better terms) Quotas benefit domestic producers by limiting import

competition

Cost to consumers ($1 billion/year in 1981–1985 for Japanese cars).

o It restricts supply which causes prices to increase (all other variables stay the same)

Consequences: high prices for consumers for the foreign good and the American good (same consequences as tariffs)

Administrative Policies: bureaucratic rules designed to make it difficult for imports to enter a country

Often are intentional but don’t have to be o (Can just be one’s way of doing business)

Some examples… o local content requirements

may try and keep you out because local producers might be worse

o licensing o permitso standards

like quality, purity, safety, etc.o regulations

(that restrict access to the market) Can be difficult to identify, address, and determine what the

effects are More of a problem than the other trade effectors

o HUGE problem in Africa***o “We talked about an array of administrative policies that

can affect trade. These issues are evident in the following video about trade among some African countries.”

o https://www.youtube.com/watch?v=4f9aZrWdnFc o 3.) Subsidies:

Subsidy: a payment (assistance) to a domestic producer (doesn’t necessarily have to be cash)

Cash grants low-interest loans (lower than market interest rates) tax breaks government participation of the equity in the company

o Ex: Airbus vs. Boeing…

Airbus is a consortium. French, German, and UK governments all own a part of it

Boeing can’t compete with 3 governmentsU.S. subsidizes Boeing

Who pays for subsidies? Subsidies are generated from taxes Taxes are paid by tax payers… Tax payers pay the government… The government pays for subsidies

Annual Cost to American Consumers for Import Protection

o green: the amount of extra money that American consumers have

paid. (Majority goes towards producers) Retaliation…Helms-Burton Act:

o Passed in 1996o Allows Americans to sue foreign firms that use property in Cuba that was

confiscated from them after the 1959 revolutiono Backlash from Canada and Europe…

(you can’t tell us what our firms can or can’t do in Cuba) Violates a state’s sovereignty (our sovereignty rights were violated) Still on the books, but has never really been enforced

o (not expected to know this because it hasn’t been enforced) General Agreement on Tariffs and Trade (GATT) ***

o WWII allies want international organization in trade arena similar to UN in political arena

Idea: If the countries had economic relationships, they’d be less likely to have a war

(After WWII, main priority is keeping WWIII from happening)

o GATT proposed by US in 1947 as a step toward an international trade organization

Goal: set up organization to facilitate tradeo GATT had 19 original members

Idea of multilateral agreemento Goal: to reduce tariffs and facilitate tradeo How does it facilitate trade?

Multilateral Agreement : objective is to liberalize trade by eliminating tariffs, subsidies, import quotas, etc. using “Most Favored Nation” status

“Most Favored Nation” status :o Most of the developed nations have this statuso An agreement with 2 most favored nations applies to all

other most favored nations Ex: Italy and US (2 most favored nations) strike a

negotiation. The negotiation would then apply to all other most favored nations

Much more efficient than bilateral. It involves all countries, reducing costs and time

o Used “rounds” to gradually reduce trade barrierso Products of developing countries are sometimes given duty free access to

developed oneso GATT Negotiating Rounds…

Geneva 1947 23 Annecy 1949 13 Torquay 1950-51 38 Geneva 1956 26 Dillon 1960-62 45 Kennedy 1964-67 62 Tokyo 1973-79 99 Uruguay 1986-94 117 Doha?

Doha Discussions started a while ago. Big divide between what the developed countries want and what the developing countries want

o (India not happy about the Doha rounds at the moment)

Uruguay much longer round than others and had much more participating countries

World trade and world income have increased Average Reduction in US Tariff Rates 1947–1985

o very high tariff rates on average coming into the U.S.

pre-Genevao Impact of GATT…

Currently, >120 members Represents 90% of world trade 9 of 10 disputes satisfactorily settled

did a good job at settling trade disputes Tariff reduction from 40% to 5% Trade volume of manufactured goods has increased 20 times

o Uruguay Round (1986-1984) Most comprehensive trade agreement in history (to that date) Created the World Trade Organization (WTO) (During this round…GATT mutated into the WTO)*** Impacted:

Agriculture subsidies (stumbling block: U.S./EU) Applied GATT rules for goods to services and intellectual

property issueso First time addressing services and intellectual property

issues Strengthened GATT monitoring and enforcement of trade

agreementso Leading Exporters of Services

U.S. is largest exporter of services

o GATT Criticisms… Economic theories don’t fit the “real world” model

They don’t really address the underdeveloped countries’ needs U.S. global superiority has declined

“Same time as tariffs decreasing, so GATT must be reason for decline”

American percentage of the global markets declinedmost of that decline was natural; some due to increased globalization, some due to more competition from countries, some due to Japan’s technological advances (the playing field is more level)

this shows up recently in the presidential election…o Clinton signed NAFTA into law. Was started by Busho “Global Elites”, “America First“o saw more of an isolationist sort of discussion across the

political parties. That manifests in some of Trump’s decisions

Shift from cutting tariffs to eliminating non-tariff barriers angered countries & created some resentment

“National Treatment” or “Most Favored Nation” status results in inequalities

developed vs. developing nations has led to disputes between these nations

World Trade Organization (WTO) ***o (GATT mutated into WTO after Uruguay round)o Umbrella organization for GATTo Mission: “ensure that trade flows as smoothly, predictably, and freely as

possible” Job # 1: Facilitate trade Job # 2: Arbitrate disputes

o Responsibility for trade arbitration: Reports adopted unless specifically rejected After appeal, failing to comply can result in compensation to injured

country or trade sanctions Ex: U.S. with beef dispute

o WTO -World Policeman? 104 disputes brought to WTO in first three years (196 in 50 years of

GATT) Probably the case: WTO is a better mechanism for resolving

trade disputes U.S.: 108 cases as complainant (we’ve filed the complaint); 124 as

respondent (we’ve had the complaint filed against us). Big wins: beef & bananas Big loss: Kodak (Kodak filed suit against Fuji for film and what

they considered unfair trade practices. Lost the suit and the appeal)

Overall, financial services (one of the biggest service exports) and telecommunications have been big winners

PORTER’S GUIDELINES FOR GOVERNMENT POLICIES…o Focus on specialized factor creation

Resources=factors “improve education” Incentive capital formation (tax breaks, etc.) for higher productivity

o Avoid intervening in factor & currency markets Don’t intervene in resource markets Porter doesn’t like messing with capital markets UK doesn’t even have a minimum wage

o Enforce strict product, safety, & environmental standards Porter likes intervention in this case: you’re going to have to meet

product, safety, and environmental standards anyways, and all of these are good for sustainability

o Limit direct cooperation among industry rivals Porter believes cooperation reduces rivalry. Not a good thing. Doesn’t like strategic cooperation between direct rivals (ex: Toyota &

BMW)o Promote sustained investmento Deregulate competition

o Enforce strong domestic antitrust policies anything that interferes with competition…Porter doesn’t favor

makes sense with diamond modelo Reject managed trade

Porter doesn’t like governments making decisions that should be made in the market place

(“Markets should make decisions with trade. Not governments”)

o “Facilitating the climate for doing business”

o ^^ graph of U.S. business environment compared to other developed

countries (ex: Australia, Japan, Western Europe, etc.) upper right (green): all about innovation, capitalizing on innovation,

etc. lower right (orange): lower left (red): tax code has kind of improved since this graph was

made. We have addressed some regulation. Main thing=political system and has gotten worse. (winner take all idea. Republicans vs. democrats. Merely two divided parties that don’t work together well. Need to remember: We are Americans first. Democrats or republicans second

(Chapter 8: INVESTMENT)

International Investmento Investment is kind of the sister of tradeo Trade and investment may be complements or substitutes

Ex: South Africa… Substitutes: (of trade) you are exporting to South Africa and

they decide to raise tariffs. Afraid not competitive so you establish manufacturing in South Africa and no longer export

Complements: if you use manufacturing in South Africa to trade to other neighboring African countries

o Two types of investment… 1. Portfolio Investment:

mostly about people or individuals control of the foreign assets is < 10%

2. Foreign Direct Investment (FDI): mostly about countries or companies control of the foreign assets is > 10% more common type of investment most important for the MNCs

o investment is decreasing at somewhat the same rate as trade haso Control is the major issue

The difference is control of the foreign assets Magic number = 10%

If less than 10% of control on foreign assets= portfolio investment

If more than 10% of control on foreign assets= FDIo (Currency value and political risk play heavily in this)

Foreign Direct Investment (FDI)o (We are mostly talking about the globalization of production. Investing to

producing markets in foreign countries instead of exporting to them)o FDI is a primary means of going international, one that allows the MNC to

avoid trade barrierso Two basic strategies of FDI (acquisition vs. greenfield)

Ex: want boots on ground. You either… Acquisition: acquiring an existing company

Advantages buy competitive advantages of the firm (helps you compete when bought), and speed (as soon as the deal is signed, you have profits)

Disadvantages expensive (paying a premium of the company or a ‘goodwill’ according to accountants), integration, “brown field” (buy a company knowing it’s not up to competitive standards. Have to pour cash in it to make it “green”)

ex: go to Japan and buy a Japanese company Greenfield: create company in another country

advantages it’s cheaper, complete control from day 1 disadvantages slower process, market penetration issues

(liability of being foreign) ex: go to Japan and create a company

Some companies use a mix of the strategies (ex: Starbucks) Foreign Direct Investment (FDI)

o FDI is explained by demand, supply, and governmental factors… Demand factors: customer access & mobility, protecting intellectual

property Supply Factors: logistics (transportation costs, perishability, etc.),

resource availability (cheaper labor, lower taxes, etc.), technology access, & production costs

Political Factors: trade barriers (incentivizes FDI) & development incentives (offering incentives to foreign companies)

o Theories of FDI… Ownership Advantage Theory: FDI occurs when firm advantages can

be transferred to foreign markets Idea: FDI is going to occur if the company can transfer

competitive advantages to host country Internalization Theory: when transaction costs are high, FDI will occur

Internalize it or externalize it?o External: have transaction costs (ex: monitoring

contracts, negotiating contracts, transportation, etc.) Which is better/less costly? FDI or contracting to foreign

companies? Eclectic Theory: combination that suggests FDI occurs when there are

advantages from location, ownership, or internalization going to happen when location economies realize (cheaper

labor, lower taxes), and if there are lower costs, to do it yourself

o U.S. has been a proponent of FDI for a while. Trump administration not as much a fan of completely open FDI wants to bring manufacturing back to the U.S. (tax rates to incentivize to bring back U.S. company manufacturing)

o Sources of FDI into U.S…. 1. Netherlands 2. France 3. United Kingdom 4. Japan 5. Canada 6. Belgium 7. Cayman Islands 8. Luxembourg 9. S. Korea 10. Hungary 11. Germany 12. Mexico 13. Sweden 14. Singapore 15. Italy

o FDI into U.S. by Industry… 1. Manufacturing 2. Trade and repairs 3. Mining and quarrying 4. Electricity, gas and water 5. Other services 6. Construction 7. Hotels and restaurants 8. Financial intermediation 9. Agriculture and fishing 10. Real estate, renting and business activities 11. Transport, storage and communication

o Destinations of U.S. FDI… 1. Netherlands 2. United Kingdom 3. Luxembourg 4. Bermuda 5. Canada

6. Cayman Islands 7. Ireland 8. Australia 9. Switzerland 10. Singapore 11. Mexico 12. Brazil 13. Germany 14. Norway 15. Chile

o FDI from U.S. by Industry 1. Real estate, renting and business activities 2. Manufacturing 3. Trade and repairs 4. Mining and quarrying 5. Financial intermediation 6. Other services 7. Transports, storage and communication 8. Hotels and restaurants 9. Electricity, gas and water 10. Construction 11. Agriculture and fishing

o Trends in FDI… Developed Developed Developed Developing Developing Developed

o (India will probably take over for the # 1 FDI destination (instead of China) because of things like democratic government, English widely spoken, cheap labor, lower levels of corruption, good large ports, possible trade war with China, etc.)

o U.S. FDI Position

o Host Country FDI Benefits…

Creates demand for exports & jobs Increased technology & knowledge

Knowledge: management skills, knowledge of the industry, manufacturing process, etc.

Lower consumer prices Increased productivity

Knowledge and technology could increase productivity Product & process innovation Economic growth

o Host Country FDI Problems… Can drive out local competitors Can prevent development of local competitors

Can be a deterrent Profits may go “home”

(repatriating profits) Can hurt national sovereignty & national defense

(depending on the defense) Parts imported for assembly hurt trade

o Home Country FDI Problems… Job loss

Issue the Trump administration is most concerned about Outsourcing and offshoring

Can hurt trade balance Reduces exports MNC may export to home country

o Encouraging FDI… Risk insurance (Home)

To deal with political and legal risk Elimination of double taxation (Home)

Eliminate unfavorable tax treatments Tax incentives (Host)

Provide tax incentives to attract FDI Low interest rates (Host) Stable government & policies (Host)

Best way to attract FDI***

(Chapter 9: ECONOMIC INTEGRATION) Economic integration is what economists call it Regional Economic Integration

o Agreements among countries in a geographic region to reduce, and ultimately remove, tariff and nontariff barriers to the free flow of goods, services and factors of production among each other.

o Another attempt to what WTO wants (to facilitate more free trade among member countries)

Economic Case for Regional Integration (economic rationale)o Allows companies to capitalize on their comparative advantages so they

can specialize even moreo Stimulates economic growth in all participating countrieso Countries specialize in those goods and services efficiently produced.o Additional gains from free trade beyond international agreements such as

GATT and WTO. Political Case for Economic Integration (political rationale: major driving force for

EU)o (If there are economic links b/w countries, there is incentive to solve

problems and not go to war)o Economic interdependence creates incentives for political cooperation and

reduces potential for violent confrontation.o Together, the countries have the economic clout to enhance trade with

other countries or trading blocs.

o have more negotiating power than any other country alone (as a member of the EU)

Impediments to Regional Integration (downside)o Groups within countries participating in these trade blocs that may be hurt.o Remove the artificial protections by trade policies (tarrifs, etc.) and less

competitive or efficient firms will suffer because of the new competition (that are not protected anymore)

Will also cause unemployment from these kind of companies companies

o (in regard to capitalism: always a loser, whether short-term or long-term)o Potential loss of sovereignty and control over domestic issues.o Lose some of economic policy: don’t get to set monetary policies. Cant use

fiscal policy, taxing, and standards bc of regulations of EUo Debate:

Does economic integration result in trade creation or trade diversion?

(consequences: issues of trade diversion) trade diversion: implement rules of origin that specify that you

can only come freely across the border if it’s a Mexican product (different than trade deflection)

trade deflection: pay mexico to avoid tariff. o To deal with it: take a step up the “stairs” below

Levels of Economic Integration

oo (every time you take a step you include last step and add new things to

make the new step)o 5 forms of economic integration

free trade area: movement towards free flow of goods and services… ex: NAFTA 2.0

customs union: harmonized external trade policy ex: if NAFTA were to go to a customs union, US, Canada, and

mexico would have to sit down and come up with a trade negotiation with other countries and spain

common market: free up restrictions on the flow of resources (allowing resources to cross the border benefits by allowing more efficiency)

economic union: harmonized economic policy in Europe- this manifested in the euro. Didn’t have to have

euro to become a member of EU, but did have to follow guidelines

political union: one government no example of this hypothetically: closest ex would be the 50 states. (Imperfect

example)o (rule of origin: a minimum amount of a product would have to be produced

within the trading bloc) Forms of Economic Integration

oo 5 forms of integration

The European Union

oo most important trading bloc in terms of size and integrationo when soviet union collapsed and iron curtain came down, EU started

spreading easto turkey is having some problems. Provisionally a member but having

problems Turkey’s issues: economics and human rights (still have death

penalty: not allowed in EU) Would be first muslim country in EU. If became member, a Turk

could move anywhere else in EU Been going on for a while

o Fortress Europe (Don’t have to know governing aspects of European Union)** EU Political Structure

o the European Commission - proposes EU legislation, implements it, and monitors compliance

o the European Council - the ultimate controlling authority within the EUo the European Parliament - debates legislation proposed by the commission

and forwarded to it by the councilo the Court of Justice - the supreme appeals court for EU law

Rationale for the Euroo Idea: if all European countries gave up their own currencies and adopted

the Euro, it would make it easier to compare priceso easier to compare prices across Europeo increased competition promotes greater efficiencies in production

o the pan-European capital market should further develop and reduce the risks of exchange rates and facilitate more

investment in Europeo range of investment options open both to individuals and institutions

should increase ex: if you wanted stock, easier to access

o (still don’t have to adopt the Euro to be a member of the EU.) English did not do it. Still have pounds as currency method Denmark has yet to adopt Euro as well

o WEST

NAFTA: 2nd most important trading bloc (after the EU) Moving WEST NAFTA: North American Free Trade Agreement

o Became law: January 1994o Over 15 year period:

tariffs reduced (99% of goods traded) reduced trade barriers NTBs reduced Increased FDI opportunities investment opportunities increased

o Protects intellectual propertyo Applied national environmental standardso Special treatment for many industries, with agriculture being an issue

2 big hold ups: agriculture and intellectual propertyo accounts for about 1.2 trillion $ in trade. Ultimately beneficial to all 3

countries

USMCA (NAFTA 2.0)o Us, mexcio, Canadao Core of NAFTA is still in placeo CHANGED…o Changed the rules of origin on automobiles (75% of car has to be made in

NAFTA countries)o Changed labor: 40-45% of all auto content minimum wage is $16 per

hour Protects mexico. Specifically geared to stop some job loss for cheap

labor in mexico Helps workers in mexico…BUT what will that do to the price of cars

Also provided protection for women and immigrants in Mexico Gives the right of union representation to Mexican workers

o More US farmer access to Canada Farmers in U.S. were affected

o Extends the intellectual property protection Helps pharmaceutical No tariffs on e-commerce

o Maintains the mechanism for dealing with disputes Trade dispute mechanism maintained; limits investors suing

governmentso Provision: there will be a periodic review

2020: periodic review 16 year sunset clause (exit clause)

Move more SOUTH: ANCOM: Andean Pact

o Bolivia, Colombia, Ecuador and Peru (Venezuela left for Mercusor)o Cartagana Agreement, 1969: One of oldest still in existenceo Changed from FTA to customs union in 1992o Population: 100 milliono Collective GNP ~ $900 billiono 4 countries: 3 of which need the economic boost

Bolivia and Ecuador are dealing with economic issues. Bad economy. Peru is struggling as well.

o (chile was a member, but they pulled out) The Mercosur Accord

o Bigger of the 2 arrangements in south America

Because contains 2 of the biggesto 1988: Argentina, Brazil. 1990: Paraguay, Uruguay, and recently, Venezuelao 1995: Agreed to move toward a full customs union, and goal is to become

common market (which is still a long way aways).o Population: 250 million (probably wrong)o ¾ of South America’s economic activity occurs within this bloco Trade doubled in first 3 years after implementationo Link to Andean countries:

Bolivia, Chile, Colombia, Ecuador & Peru are associate members (FTA, but not in customs union)

More EAST: ASEAN: Association of Southeast Asian Nations

o Created in 1967 by Indonesia, Malaysia, Philippines, Singapore & Thailand (later joined by Myanmar, Cambodia, Laos and Vietnam)

o Economic (FTA), political and social cooperation also trying to slowly move towards a common market

o about 600 million peopleo Collective GNP ~ $1.8 trillion

The ASEAN Members

oo around south-east asia (almost the entirety)

(include) Cambodia and laos Asia-Pacific Economic Cooperation Initiative (APEC)

o not a trade bloc. A loose cooperative organization Russia is also in it (update) Come together annually to talk about trade and practical cooperation

and talk about common concerns (social problems, terrorism, etc) APEC: Asia Pacific Economic Cooperation

o Founded in 1989 to ‘promote open trade and practical economic cooperation’ and a ‘sense of community’

o 21 members (Russia most important recent addition) with combined population of 2.7+ billion

o GDP (PPP adjusted): $44 trilliono Over half of world income and trade

Free Trade Agreements in Africa

oo in Africa (3 major trade blocs, segregating the country)

idea: the 3 major trade blocs will combine into 1 Trans-Pacific Partnership (TPP)

o (Trump withdrew us from this…Would have been the largest trade agreement)

o Proposed trade agreement between the U.S. and Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam to increase trade and cooperation

o Projected benefits would have been $295 billion annuallyo Interesting: did more than any trade agreement thus far to protect from …

Possible requirements on labor and environmental rules, intellectual property and challenging countries’ regulations

o Question: will China step in and benefit from what we chose not to step in on?

Implications for Managerso Question: Why is regional economic integration important to international

companies? Markets that had been protected from foreign competition are

increasingly open (changes opportunities and threats) Particularly significant in the EU and NAFTA 2.0 Increases competition

Regional economic integration means that markets that had been protected from foreign competition are increasingly open

these developments are particularly significant in the European Union and NAFTA

However, regional economic integration is likely to increase competition

Fortress Europe: (around 1980s) going to be hard to get into. Concerned with the idea that it would be harder to get your product into Europe. IDEA: get in before they make it harder to do so. (if you think the bridges will be drawn, try to get in as much as possible. Rush to try and get more foreign direct investment in that country)

o Suggests trade diversion: policies that favor higher cost producers in the bloc over more efficient producers outside the bloc***

(distorts trade)