Download - Global Econ - Investment - lecture
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International Investment
Dr. Katherine Sauer
Global Economic Issues
ECON 241
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Why do firms invest abroad?
Market Seeking:
- look for new buyers (if the home market is saturated,
then to increase sales expand to a new market)
- the product may be unique or superior to the products
in the foreign market- new investments overseas may bring higher returns than
undertaking additional investments at home
Resource Seeking:
- may be cheaper to produce via a foreign subsidiary
(either for sale in the foreign market or at home)
- could obtain superior or less costly access to inputs
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Strategic Asset Seeking:
- foreign markets may offer access to new technology or
distribution networks
ex: a firm may partner with an existing foreign firm which
specializes in one aspect of the production process
Efficiency Seeking:
- firms look to put their investment money to its best use
- as economic conditions (e.g. free trade agreements,
exchange rate fluctuations) change, it can be beneficial tomove production to a different location
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Types of foreign investment
1. Commercial Loans: loans from commercial banks to foreigngovernments or to businesses abroad
2. Official Flows: development assistance from developed to
developing nations
3. Foreign Direct Investment (FDI): the purchase or construction of
a tangible asset in another country
- greenfield = build new facilities / expand existing facilities
- mergers & acquisitions
- horizontal = access to new markets at the same
stage of production
- vertical = re-locate various stages of production
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4. Foreign Portfolio Investment (FPI): investments that are more
easily traded, are usually less permanent, and usually do not
represent a controlling stake in an enterprise
FDI vs FPI
FPI tends to be more volatile than FDI.
-When a countrys economy is on the rise, FPI may increasevery quickly and can fuel rapid development, job creation,
and build wealth.
-When the economy faces a downturn or if returns dont
meet the investors expectations, the money can just as
quickly flow back out of the country.- FDI implies a controlling stake and physical assets so by
nature it is more stable.
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Factors that influence FDI decisions
- rules/regulations for the entry and operation of foreign firms- standards of treatment of foreign affiliates as compared to the
treatment of the domestic firms
- functioning/efficiency of local markets
- trade policy and privatization policy
- restrictions on repatriating earnings/profits- business facilitation measures
- investment promotion
- incentives
- improvements to amenities- other measures to decrease the cost of doing business
- export processing zones
- tax breaks
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Factors that influence FPI decisions
FPI decisions are usually tied to broad macroeconomic indicators:
- national economic growth rates- exchange rate stability
- general macroeconomic stability
- levels of foreign exchange held by central banks
- general health of the banking system
- liquidity of the stock/bond markets- interest rates
The policy environment also plays a role:
- ease of repatriating dividends/capital
- capital gains taxes
- regulation of the stock/bond markets
- quality of domestic accounting and disclosure system
- speed/reliability of dispute resolution system
- degree of protection of investors rights 7
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Possible Effects of Foreign Investment
Foreign investment has the potential to generate employment, raiseproductivity, transfer skills and technology, enhance exports, and
contribute to the long-term economic development of developing
nations.
Positive Effects in the Host Country:
1. A country receives capital.
- A nation may have the demand and the resources needed
for production except for the capital.
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capitalinflow
firm uses funds
for start up or
expansion
start up or expansion
leads to job creation
firms generateprofits
profits fuel furtherexpansion or
investments
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2. Employment opportunities are created.
- As firms are started or expanded, jobs are created.
- Incomes increase.- Demand for goods increases.
- New opportunities for enterprise are triggered.
3. Production advantages are created.
- technology transfer: foreign firms may bring newproduction techniques the skills of the local workers are
increased
- productivity spill-over: foreign firms may bring new
methods or technologies which increases the productivity
of domestic firms (JIT)
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- improved production process: production may be made
more efficient by purchasing elements from countries
with comparative advantage or economies of scale can berealized with access to a global market
- increased competitiveness in the domestic industry:
foreign competition keeps domestic firms competitive and
backward linkages can develop (the long termrelationships that develop between a foreign firm and other
firms in the host country)
- increased outward orientation: with foreign investment,
firms are more aware of opportunities that exist in other
foreign markets and may seek to export more (improves the
BoP)
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Concerns for the Host Country:
1. problems managing capital flows
- sound financial system?
2. financial volatility
- exchange rate fluctuations?
3. contagion- herd effects if the investment climate in a similar country
sours, the host country may lose foreign investments as well
4. environmental damage
5. nationalistic concerns
- people feel uneasy about foreign control of aspects of the
domestic economy that are critical to a nations identity or
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Concerns to the domestic economy about shifting production abroad:
1. job loss- If firms in wealthier nations shut down and re-locate
production to a low cost area, domestic workers lose their
jobs.
- People may be unemployed or underemployed.
2. lower wages
- There may be downward pressure on wages domestically
because cheap labor is available elsewhere.
- An underemployed workforce draws lower wages.
(but lower wages put downward pressure on prices in general)
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3. increase in imports
-When firms locate overseas, domestic production is lowerand imports may increase.
(these kinds of investment activities comprise a small % of
total investment estimated 10% of sales of US foreign
affiliates is from sales to the US)
4. exploitation of foreign workers
5. lower levels of investment domestically
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Most economists agree that international investment can be a
powerful force for economic growth.
- Data analysis suggests that international investment iscorrelated with GDP growth.
Keep in mind:
Investment follows growth. To attract foreign investment, first acountry needs sound institutions in place.
The type of investment matters.
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Reasons FDI has been increasing in recent decades:
1. technological advances- telecommunications and transportation advances make it
easier to do business across the globe
2. lure of profits
3. fall of BerlinWall / end of the ColdWar
- countries that were centrally planned have moved toward
market based economies investors can now expect a return
on investing in those areas
4. financial liberalization
- prior to the 1970s, many countries had strict limits on
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International Investment and Sweatshops
Multinational corporations (MNCs) may be attracted to developingnations for the cheap and available low-skilled labor. (resource
seeking) - garment industry
Workers are paid little and often endure poor working conditions.Why?
- to attract workers, firms need only offer
pay/conditions that are better than the alternatives
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Isnt that exploitation?
No:
- the workers freely choose to work for low pay and in poor
conditions
- labor standards and minimum wages are different in different
nations
Yes:
-compared to the alternatives, working in a sweatshop isnt really
a choice
- there are some fundamental human rights with respect to
working conditions
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Consider this sweatshops may just be economic starter jobs in
developing nations. (Japan, South Korea, Hong Kong, Singapore,
Taiwan, US)
- as export sector grows, positive economic effects are felt
throughout the economy
- as economies grow, policy reforms also take place
My concern is not that there are too many sweatshops, but that there
are too few.
- Jeffrey Sachs
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On the other hand MNCs are earning billions of dollars in
profits. Dont they have some sort of social responsibility to
provide better conditions and higher wages for their workers?
- most workers who are employed in MNC owned and run
facilities do earn higher wages and work in better
conditions than are the norm in the local areas
- most MNC use sub-contractors for the vast majority of
their production
- the majority of documented sweatshop conditions arefound in facilities run by local sub-contractors
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Even so, shouldnt the MNCs take measures to ensure that the
sub-contractors arent abusing their workers?
- Many of the big name corporations do attempt to
monitor the conditions in the sub-contractor facilities.
- Theyve adopted codes of conduct and specify steps
that local factories must take to be an approved facility.
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Global auditing services have become a multi-million dollar
industry.
- Gap Inc. has 90 full time employees devoted tomonitoring.
- In 2005, 4,438 inspections in 2,118 facilities were
conducted. 62 factories lost approval.
-WalMart made 13,600 reviews of 7,200 facilities andbanned 141 factories from producing items forWalMart.
A new industry has sprung up in China consultants that
specialize in helping factories deal with audits from MNC
monitoring teams.
- often 2 or 3 sets of books are kept to hide violations
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Given that many MNCs are attempting to monitor the working
conditions in their sub-contractor facilities, why all the boycottfuss?
- many people feel MNCs are still exploiting their workers
because the local minimum wages are so low
- a living wage is often advocated
- many people feel that MNCs are not doing enough to
monitor and improve the situations for workers in
developing nations
- early boycotts quite possibly resulted in many MNCs
addressing social responsibility issues and formulating
Codes of Conduct for sub-contracted facilities24
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Many boycott advocates are now focused on getting MNCs to pay
higher wages to workers in developing nations.
Some possible effects of boycotts:
1. The boycott decreases the demand for an MNCs products so
the firm decides to pay higher wages to restore demand.
- workers are better off
- increased inequality between workers who work for
MNC sub-contractors and those in other jobs
- such prized jobs may then be allocated through
bribes, corruption, or favors
- if the price of the item being produced is unchanged:
- the firm has lower profits
- the firm may no longer find the developing nation
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- if the price of the item increases to reflect higher
production costs:
- consumers may be willing to pay the higher price
since the garment is sweatfree
- firms profits are unchanged
- consumers may be unwilling to pay the higher
price and the quantity demanded decreases- demand for workers also decreases
2. The boycott decreases demand for the item.
- the firms profits fall
- the firm may decrease its demand for workers
- workers lose jobs
3. Awareness is created for the issue.26