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International Trade and Foreign Direct Investment

International trade and foreign direct investment are impacted by economic theories and political/legal factors. Key theories that guide international trade include mercantilism, absolute advantage, comparative advantage, and Porter's national competitive advantage model. Political systems, legal environments, and government interventions like tariffs influence business conditions. There are two main types of international investment - portfolio investment in a company's assets/securities, and foreign direct investment to control foreign assets through purchases, joint ventures, or new facilities. Governments regulate foreign investment while companies use it to benefit.

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56 views

International Trade and Foreign Direct Investment

International trade and foreign direct investment are impacted by economic theories and political/legal factors. Key theories that guide international trade include mercantilism, absolute advantage, comparative advantage, and Porter's national competitive advantage model. Political systems, legal environments, and government interventions like tariffs influence business conditions. There are two main types of international investment - portfolio investment in a company's assets/securities, and foreign direct investment to control foreign assets through purchases, joint ventures, or new facilities. Governments regulate foreign investment while companies use it to benefit.

Uploaded by

ivan anonuevo
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© © All Rights Reserved
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International Trade and Foreign

Direct Investment

Handout 2
Prepared by Mr. TAC Alvaran

2.1 What is International Trade?


• Trade is the concept of exchanging goods and
services between two people or entities.
• If international, people and entities between two
different countries.

Types of Globalization
• Globalization 1.0- from 1492 to 1800 and
nations dominated global expansion
• Globalization 2.0- from 1800-2000,
multinational companies ascended and pushed
global development
• Globalization 3.0- at present, technology drives
global develpoment
Theories in International Trade
Classical country-based theories
• Mercantilism
• Absolute Advantage
• Comparative Advantage
Modern Firm-Based Theories
• Country Similarity
• Product Life Cycle
• Global Strategic Rivalry
• Porter’s National Competitive Advantage
Mercantilism
• Developed in the 16th century
• One of the earliest methods to develop economic
activities
• The theory states that a country’s wealth was
determined by the amount of its gold and silver
holdings.
• Done by promoting exposrts and discouraging
imports.
Mercantilism
• The objective of each company is to have trade
surplus.
• In the 1500 , there was a rise of nation-states,
rulers built larger armies and national
institutions.
• This theory also promoted protectionalism.
• Protectionalsim promooted exports and
restricted imports.
Mercantilism
• Used by nations through their colonies.
• Wealth was increased by the use of raw
materials form the colonies. (British Colonies)
Absolute Advantage
• Authored by Adam Smith
• Focused on the ability of a country to produce a
good more efficiently than another nation.
• He reasoned that the trade between two
countries should not be regulated or restricted
by government policy and intervention.
• Trade should naturally flow according to market
forces. (focus on specialization)
Comparative Advantage
• Authored by David Ricardo.
• Even if Country A had the absolute advantage in
production, specialization and trade could still
occur between two countries.
• Occurs when a country cannot produce more
efficiently than the other country, however, it
can produce that product better and more
efficiently it does other goods.
Comparative Advantage
• It focuses on the relative productivity
differences, whereas absolute advantage looks at
the absolute productivity.
Heckscher-Ohlin Theory (Factor
Proportions Theory
• Authored by Eli Heckscher and Bertil Ohlin in
the early 1900.
• Attention was focused on how a country could
gain competitive advantage by producing
products that utilized factors that were in
abundance in the country.
Heckscher-Ohlin Theory
• The theory is based on a country’s production
factors-land, labor, and capital.
• They determined that the cost of any factor or
resource was a function of supply and demand.
• Supported by the law of supply and demand.
• Cheap and surplus labor in China and India
makes them optimal location for textile and
garments production.
Modern or Firm-Based Trade Theories
• Emerged after World War II
• Developed in large part by school professors, not
economists.
• Evolved with the growth of multinational company.
• Intraindustry Trade refers to trade between two
countries of goods produced in the same industry.
Japan exports Toyota to Germany and imports
Mercedes-Benz from Germany.
• Incorporate other product and service factors,
including brand and customer loyalty, technology
and quality.
Country Similarity Theory
• Authored by Steffan Linder in 196 and tried to
explain the intraindustry trade.
• The theory proposed that consumers un
countries that are in the same or similar stage of
development would have similar preferences.
• There are similar perceptions in terms of per
capita incomes.
• Brand names and reputation are important.
Product Life Cycle
• Developed in the 1980’s by Raymond Vernon.
• Originated form the marketing field, stated that
a product life cycle has three stages; (1) new
product, (2) maturing product, and (3)
standardized product.
• The theory assumes that the production of the
new product will occur completely in the home
country of its innovation.

Global Strategic Rivalry Theory


• The theory emerged in the 1980’s and was based
on the work of economists Paul Krugman and
Kelvin Lancaster.
• Their theory focused on MNC’s and their efforts
to gain a competitive advantage against other
global firms in their industry.
• The barriers to entry refer to the obstacles a new
firm may face when trying to enter into an
industry or new market.
• The barriers to entry that corporations
may seek to optimize include:
1. Research and development (GSK)
2. Ownership of IPR (Disney)
3. Economies of scale (Coca-Cola)
4. Unique business processes or methods (Pfizer)
5. Control of resources or favorable access to raw
materials (SBUX)
Porter’s National Competitive Advantage
• Developed by Michael Porter in 1990.
• The theory stated that a nation’s competitiveness
in an industry depends on the capacity of the
industry to innovate and upgrade.
• The theory focused on explaining why some
nations are more competitive in certain
industries.
Porter’s four linked determinants:
1. Local market resources and capabilities
2. Local market demand conditions
3. Local suppliers and complimentary industries
4. Local firm characteristics
1. Local market resources
• Factor resources, natural resources and labor
are key factors in determining what products a
country will import or export.
• Advanced factors includes skilled labor,
investment in education, technology, and
infrastructure.
• These advanced factors can provide sustainable
competitive advantage.
2. Local market demand conditions
• Porter believed that a sophisticated home
market is critical to ensuring ongoing
innovation, thereby creating a sustainable
competitive advantage.
• Promotes innovation and development of
new products and technologies.
4. Local firm characteristics
• Local firm strategy, industry structure, and
industry rivalry
• Stimulates activities and innovation
2.2 Political and Legal Factors That
Impact International Trade
• A political system is basically the system of
politics and government in a country.
• It governs a complete set of rules, regulations,
institutions, and attitudes.
• Each political system has different philosophy
on the rights of the individual and the group as
well as the role of the government.
• Affects both the business environment and
economy.
• There are more than 13 types of government and
each of which has multiple variations.
• Totalitarianism
• Authoritarianism
• Democracy

A company may ask several questions


regarding a prospective country’s
government to assess possible risks:
• How stable is the government?
• Is it a democracy or dictatorship?
• If a new party comes into power, will the rules of the
business change dramatically?
• Is power concentrated in the hands of a few, or is it
clearly outlined in a constitution or similar national
legal document?
• How involved is the government in the private
sector?

• Is there a well-established legal environment


both to enforce policies and rules as well as to
challenge them?
• How transparent is the government’s political,
legal, and economic decision-making process?
Legal Systems
• There are three main kinds of legal systems:
1. Common law
2. Civil law
3. Religious or theocratic law
• Most countries have a combination of the three.
Government intervention
• Tariffs- taxes imposed on imports and can be
specific (fixed charges) or andad valorem
(computed percentage)
• Subsidies- form of government payment to a
producer, can be tax breaks, low-interest loans,
cash grants, and government equity
participation.

• Import quotas or VER (voluntary export


restraints)- limits the amount of imports.
• Currency controls
• Local content requirements- many countries
continue to requirements- many countries
continue to require that a certain percentage of a
product or an item be manufactured or
“assembled” locally.
• Antidumping rules- dumping occurs when a
company sells product below market price often
in order to win market share and weaken a
competitor.
• Export financing- government provides
financing to promote exports.
• Free-trade zone-many countries designate
certain geographic areas as free-trade zones.
• Administrative policies- policies that make
trading difficult and time-consuming.
2.3 International Investments
• Two main categories of international investment
1.Portfolio investment- refers to the investment in
a company’s stocks, bonds, or assets, but not for
the purpose of controlling or directing the firm’s
operations or management.
2. Foreign direct investment- refers to an
investment in or the acquisition of foreign assets
with the intent to control and manage them.
• Can be done by purchasing assets of a foreign
company, investments, or joint venture.
• Can be inward or outward, the difference
between the two is net FDI inflow.

• Governments want to be able to control and


regulate FDI.
• Global businesses are most interested in using
FDI to benefit their companies. At times, conflict
arises.
FDI considerations
• Cost
• Logistics
• Market
• Natural resources
• Know-how
• Customers and competitors
• policy
• Ease
• Culture
• Impact
• Expatriation of funds
• Exit
Kinds of FDI
1. Greenfield FDI- occurs when multinational
corporations enter into developing countries to
build new factories or stores.
• Has long term effect especially in employment.
• Conversion of “green fields” such as farms and
forests into factories.
2. Brownfield FDI is when a company or
government entity purchases or leases existing
production facilities to launch a new production
activity.
• Unclean businesses such as still mills or oil
refineries are converted into more environment
facilities such as commercial areas or offices.
• Can also be converted into residential areas.
• Faster to implement.
• Has to deal with many challenges including
existing employees, outdated equipment,
entrenched processes, and cultural differences.
How the governments discourage and
restrict FDI
• Ownership restrictions
• Tax rates and sanctions
How governments encourage FDI
• Financial incentives (reduced taxes and loans)
• Infrastructure
• Administrative processes and regulatory
environment
• Invest in education

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