Dispense TOPICS in Global Market, Dispense di Crescita e Globalizzazione

Scarica Dispense TOPICS in Global Market e più Dispense in PDF di Crescita e Globalizzazione solo su Docsity! GLOBAL MARKET – TOPICS IN GLOBAL MARKET (HELG) 1 - GLOBALIZATION Agenda: 1. Market and production globalization 2. Historical digressions 3. 2 drivers of globalization 4. International institutions 5. Changing demographics in global economy 6. Pro and contra globalization 7. Globalization and world poverty and inequality 1.MARKET AND PRODUCT GLOBALIZATION WHAT IS GLOBALIZATION? The world is moving away from self-contained national economies toward an interdependent, integrated global economic system Globalization refers to the shift toward a more integrated and interdependent world economy Globalization has two facets: 1. the globalization of markets 2. the globalization of production GLOBALIZATION OF MARKETS Historically distinct and separate national markets are merging. It no longer make sense to talk about the “German market” or the “American market”. Instead, there is the “global market” • Falling trade barriers make it easier to sell globally • Consumers' tastes and preferences are converging on some global norm • Firms promote the trend by offering the same basic products worldwide (standardization) In 2015 the blu line is much bigger than production. Every observation in production in $ is divided by the production of 1950 in $ x 100, in this way dollars are no more To understand that the international part of the production has raised more than the national part. Big drop in blue line during the 2011's Great Depression. AND NOW WHAT HAPPENS? In 2007/2008 the world was hit by the Great Recession. In the last 4 years there have been two additional exogenous shocks that might reinforce the slowing down of globalization: considered. Inflows: country that received investment from abroad Historically this has been primarily confined to manufacturing enterprises Increasingly companies are taking advantage of modern communications technology, and particularly the Internet, to outsource service activities to low-cost producers in other nations The production process has been fragmented internationally FRAGMENTATION: The splitting of production processes into separate parts that can be done in different locations, including in different countries. One of many terms for the same phenomenon, this particular one originated with Jones and Kierzkowski (1990). • International fragmentation of production generates trade in intermediate inputs. • International outsourcing of productive activities to different suppliers results in the creation of products that are global in nature Estimates suggest that a large share (possibly nearly 2/3rds) of world trade is in intermediate goods. This suggests that a lot of production activity is being internationally fragmented. Or equivalently that the modern global economy features lots of what gets variously called: • Offshoring • Slicing up of the value chain (internationally). • Vertical specialization. • Outsourcing. • Disintegration of production. • Multi-stage production. • Intra-product specialization. It thus seems important to understand this force for trade, and to understand its consequences for domestic economies in which international fragmentation is increasingly possible. Outsourcing of productive activities to different suppliers results in the creation of products that are global in nature. Examples Barbie: an early example of international fragmentation of production • Barbie produced by the American company Mattel is considered a global good • Mattel does not own production plants in the USA. • Plastic for the body and hair comes from Taiwan and Japan. • Moldes and colors from USA. • Assembly used to take place in Philippines and Taiwan, but it was then moved to other countries in SouthEst Asia (Indonesia, Malaysia , China). • Cotton cloth for dresses comes from China. • Most Barbie dolls are shipped to USA from Hong Kong. • Value of the doll in Hong Kong (1995) was 2$: 35 cents labor, 65 cents materials, 1$ intermediation and trasport. • Sale price in USA was about 10$: 1$ Mattel profits and the rest general overhead and distribution costs and margins, etc. A more recent example: Boeing 787 Dreamliner • Offshore production accounts for 70% of parts • 43 suppliers in 135 sites • Most tasks performed in high-income countries • No clear pattern of technological advantage; experience and local knowledge play central role “Spiders” involve multiple parts coming together from a number of destinations to a single location for assembly of a new component or final product. Most production processes are complex mixtures of the two. TRADE IN VALUE ADDED • The goods and services we buy are composed of inputs from various countries around the world. However, the flows of goods and services within these global production chains are not always reflected in conventional measures of international trade. • The joint OECD – WTO Trade in Value-Added (TiVA) initiative addresses this issue by considering the value added by each country in the production of goods and services that are consumed worldwide. TiVA indicators are designed to better inform policy makers by providing new insights into the commercial relations between nations. VALUE CHAIN OF ACTIVITIES The Value Chain of a Product Any product has many different activities involved in its manufacture. Panel (a) lists some of these activities for a given product in the order in which they occur. The value chain in (b) lists these same activities in order of the amount of high- skilled/lowskilled labor used in each. In panel (b), the assembly activity, on the left, uses the least skilled labor, and R&D, on the right, uses the most skilled labor. Because we assume that the relative wage of skilled labor is higher at Home and that trade and capital costs are uniform across activities, there is a point on the value chain, shown by line A, below which all activities are offshored to Foreign and above which all activities are performed at Home. GLOBAL VALUE CHAIN One aspect of production fragmentation has been the growth of Global Value Chains (GVC). Recently, but even before the start of the pandemic, GVC stopped growing The reduction is due to many factors: 1. Lower average GDP growth 2. Delocation has become less relatively convenient 3. China has become more inward oriented: in the 1990s the share of intermediate imports contained in Chinese exports was about 50%, in 2015 down to 30% Again, don’t exaggerate the degree of production globalization. Obstacles remains: • Formal and informal barriers to trade • Barriers to foreign direct investment • Transportation costs • Issues associated with economic risk • Issues associated with political risk A group of economist (see Gene Grossman and Rossi- Hansberg, 2006 and the presentation by Richard Baldwin, 2006)) have introduced the idea that with outsourcing globalization has entered a new phase. The idea is that in the first phase globalization has been characterized by a first unbundling: end of the necessity of making goods close to the point of consumption. In this first phase we had trade in goods. Recently, started a second unbundling: the end of the need to perform most production stages near each other. In this second phase we have trade in tasks. GLOBALIZATION AND LABOUR MARKET Goods, services, capital markets have become less regulated over the last 50 years. What about the labour market? The INTERNATIONAL MONETARY FUND (1944) • maintains order in the international monetary system • lender of last resort for countries in crisis ◦ Argentina, Indonesia, Mexico, Russia, South Korea, Thailand, Turkey, Ireland, and Greece The WORLD BANK (1944) • promotes economic development via low interest loans for infrastructure projects The UNITED NATIONS (1945) • maintains international peace and security • develops friendly relations among nations • cooperates in solving international problems and in promoting respect for human rights • is a center for harmonizing the actions of nations The G20 • forum through which major nations tried to launch a coordinated policy response to the 2008-2009 global financial crisis 5. DEMOGRAPHICS CHANGES IN GLOBAL ECONOMY WHAT DOES GLOBALIZATION MEAN FOR FIRMS? Technological change means • lower transportation costs ◦ help create global markets and allow firms to disperse production to economical, geographically separate locations • low cost information processing and communication ◦ firms can create and manage globally dispersed production • low cost global communications networks ◦ help create an electronic global marketplace • global communication networks and global media ◦ create a worldwide culture and a global consumer product market THE CHANGING DEMOGRAPHICS OF THE GLOBAL ECONOMY Four trends are important: 1. The changing world output and world trade picture 2. The changing foreign direct investment picture 3. The changing nature of the multinational enterprise 4. The changing world order HOW HAS WORLD OUTPUT AND WORLD TRADE CHANGED? In 1960, the U.S. accounted for over 40% of world economic activity, but by 2012, the U.S. accounted for just 23% ◦ a similar trend occurred in other developed countries In contrast, the share of world output accounted for by developing nations is rising ◦ expected to account for more than 60% of world economic activity by 2020 Economic power is shifting and this implies convergence 6. PRO AND CONS GLOBALIZATION HOW WILL THE GLOBAL ECONOMY OF THE 21ST CENTURY LOOK? The world is moving toward a more global economic system But globalization is not inevitable —> there are signs of a retreat from liberal economic ideology in Russia and other countries Globalization brings risks • the financial crisis that swept through South East Asia in the late 1990s • the recent financial crisis that started in the U.S. in 2007-2008, and moved around the world • the more recent pandemic has been facilitated by globalization IS AN INTERDEPENDENT GLOBAL ECONOMY A GOOD THING? SUPPORTERS believe that increased trade and cross-border investment mean • lower prices for goods and services • greater economic growth • higher consumer income, and more jobs CRITICS worry that globalization will cause • job losses • environmental degradation • the cultural imperialism of global media and MNEs Anti-globalization protesters now regularly show up at most major meetings of global institutions and is a common element among populist- nationalistic-identitarian political parties. HOW DOES GLOBALIZATION AFFECT JOBS AND INCOME? Critics argue that falling barriers to trade are destroying manufacturing jobs in advanced countries Supporters contend that the benefits of this trend outweigh the costs • countries will specialize in what they do most efficiently and trade for other goods— and all countries will benefit But now there is a new threat to human jobs: machines (robot) HOW DOES GLOBALIZATION AFFECT LABOR POLICIES AND THE ENVIRONMENT? Critics argue that firms avoid the cost of adhering to labor and environmental regulations by moving production to countries where such regulations do not exist, or are not enforced Supporters claim that tougher environmental and labor standards are associated with economic progress • as countries get richer from free trade, they implement tougher environmental and labor regulations HOW DOES GLOBALIZATION AFFECT NATIONAL SOVEREIGNTY? Is today’s global economy shifting economic power away from national governments toward supranational organizations like the WTO, the EU, and the UN? Critics argue that unelected bureaucrats have the power to impose policies on the democratically elected governments of nation-states. Supporters claim that the power of these organizations is limited to what nation-states agree to grant • the power of the organizations lies in their ability to get countries to agree to follow certain actions 7. GLOBALIZATION AND THE WORLD POVERTY AND INEQUALITY HOW IS GLOBALIZATION AFFECTING THE WORLD'S POOR? Is the gap between rich nations and poor nations getting wider? Critics believe that if globalization was beneficial there should not be a divergence between rich and poor nations Supporters claim that the best way for the poor nations to improve their situation is to • reduce barriers to trade and investment • implement economic policies based on free market economies • receive debt forgiveness for debts incurred under totalitarian regimes Global inequality: 1998-2008 Global inequality from 2008 to 2013 is declining worldwide Inequality has been increasing up to 1880. In 1920 almost all inequality was within country. Progressively, the between country inequality started increasing (because just some of them adopted the capitalist economic engine, the gap between those countries which hadn’t adopt it consequently increased). After 1980, inequality started going down, the motivation is due to a reduction in the average between countries inequality, since developing countries (China, India, Nigeria etc) are catching up developed countries. America and Europe have to reduce inequality. Globalization has partially increased inequality, but it has also partly reduced it, since it contributed to growth in many Asian countries. HOW DOES THE GLOBAL MARKETPLACE AFFECT MANAGERS? Managing an international business differs from managing a domestic business because • countries are different • the range of problems confronted in an international business is wider and the problems more complex than those in a domestic business • firms have to find ways to work within the limits imposed by government intervention in the international trade and investment system • international transactions involve converting money into different currencies 2. INTERNATIONAL TRADE THEORY WHY IS FREE TRADE BENEFICIAL? Free trade - 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 Trade theory shows why it is beneficial for a country to engage in international trade even for products it is able to produce for itself. INTERNATIONAL TRADE ALLOWS A COUNTRY: § to specialize in the manufacture and export of products and services that it can produce efficiently § import products and services that can be produced more efficiently in other countries § limits on imports may be beneficial to producers, but not beneficial for consumers WHY DO CERTAIN PATTERNS OF TRADE EXIST? - Some patterns of trade are fairly easy to explain - it is obvious why Saudi Arabia exports oil, Ghana exports cocoa, and Brazil exports coffee - But, why does Switzerland export chemicals, pharmaceuticals, watches, and jewelry? - Why does Japan export automobiles, consumer electronics, and machine tools? WHAT ROLE DOES GOVERNMENT HAVE IN TRADE? The mercantilist philosophy makes a crude case for government involvement in promoting exports and limiting imports. Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade. New trade theory and Porter’s theory of national competitive advantage justify limited and selective government intervention to support the development of certain export-oriented industries. WHAT IS MERCANTILISM? Mercantilism (mid-16th century) suggests that it is in a country’s best interest to maintain a trade surplus -to export more than it imports. This theory advocates government intervention to achieve a surplus in the balance of trade Mercantilism views trade as a zero-sum game - one in which a gain by one country results in a loss by another. However, in 1752, David Hume pointed out that: • Increased exports lead to inflation and higher prices • Increased imports lead to lower prices Result: Country A sells less because of high prices and Country B sells more because of lower prices. In the long run, no one can keep a trade surplus and the trade balance will balance. NEW VERSION: Export is good because it increases production and more jobs are created, while import is bad because it reduces my production and jobs are lost. What is Smith’s theory of absolute advantage? Adam Smith (1776) argued that a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it Therefore, countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for goods produced by other countries. How does the theory of absolute advantage work? 2 countries: Ghana is better in producing cocoa (it has an absolute advantage in producing cocoa), while South Korea is better at producing rice (it has an absolute advantage in producing rice). Assume that two countries, Ghana and South Korea, both have 200 units of resources that could either be used to produce rice or cocoa In Ghana, it takes 10 units of resources to produce one ton of cocoa and 20 units of resources to produce one ton of rice. Ghana could produce 20 tons of cocoa and no rice, 10 tons of rice and no cocoa, or some combination of rice and cocoa between the two extremes In South Korea it takes 40 units of resources to produce one ton of cocoa and 10 resources to produce one ton of rice. South Korea could produce 5 tons of cocoa and no rice, 20 tons of rice and no cocoa, or some combination in between. Without trade: - Ghana would produce 10 tons of cocoa and 5 tons of rice - South Korea would produce 10 tons of rice and 2.5 tons of cocoa With specialization and trade - Ghana would produce 20 tons of cocoa ¬South Korea would produce 20 tons of rice - Ghana could trade 6 tons of cocoa to South Korea for 6 tons of rice After trade - Ghana would have 14 tons of cocoa left, and 6 tons of rice - South Korea would have 14 tons of rice left and 6 tons of cocoa - If each country specializes in the production of the good in which it has an absolute advantage and trades for the other, both countries gain ¬trade is a positive sum game In the table we have: § Ghana has a Comparative Disadvantage in R § South Korea has a Comparative Disadvantage in C (cause Ghana has a comparative advantage in C) COMPARATIVE ADVANTAGE AND THE GAINS FROM TRADE: AN ALTERNATIVE PROOF Ricardo suggests that each country should produce and export the good in which it has a comparative advantage. Following this strategy both countries will gain from trade. Let’s proof this gains from trade result. The proof treats international trade as an alternative production process. For Ghana the Ricardian suggestion is to stop producing domestically rice. Let’s compare the two strategies to bring rice on the table of domestic consumers: A=autarky (no trade) and FT (free trade) In the international market, Ghana change cocoa for rice and South Korea change rice for cocoa. For South Korea the Ricardian suggestion is to stop producing domestically Cocoa. Let’s compare the two strategies to bring cocoa on the table of domestic consumers: 1 hour labor produces 1/40 of cocoa (Pc/Pr) of Ghana= 10/13,33 (Pr/Pc) of SK = 40/20 =2 That’s why we are in favor of the trade. IS UNRESTRICTED FREE TRADE ALWAYS BENEFICIAL? Unrestricted free trade is beneficial, but the gains may not be as great as the simple model of comparative advantage would suggest - Immobile resources - Diminishing returns - Dynamic effects and economic growth - The Samuelson critiques But opening a country to trade could increase § A country’s stock of resources as increased supplies become available from abroad § The efficiency of resource utilization and so free up resources for other uses § Economic growth COULD A RICH COUNTRY BE WORSE OFF WITH FREE TRADE? Paul Samuelson - the dynamic gains from trade may not always be beneficial. - free trade may ultimately result in lower wages in the rich country The ability to offshore services jobs that were traditionally not internationally mobile may have the effect of a mass inward migration into the United States, where wages would then fall But, protectionist measures could create a more harmful situation than free trade CAUSES OF INTERNATIONAL TRADE 1- differences among countries à PRINCIPLE OF COMPARATIVE ADVANTAGES § RICARDO: difference relative labour productivity § HECKSCHER-OHLIN (H-O): difference relative factor endowments/abundacy 2- Imperfect competition + increasing returns to scale § MONOPOLY COMPETITION (Krugman, Helpman, Grossman) § OLIGOPOLY (Brander, Krugman) HECKSCHER-OHLIN THEORY Eli Heckscher (1919) and Bertil Ohlin (1933) - comparative advantage arises from differences in national factor endowments. The extent to which a country is endowed with resources like land, labor, and capital. The more abundant a factor, the lower its cost. In this model same hps. as in Ricardian model, but for: - Existence of 2 factors of productions (K and L) - Countries differ in terms of relative factor endowment Some definitions: A country (the US) is relatively abundant in capital (K) if: (K/L)USA>(K/L)RW The production of a good (1) is capital intensive if: K1/L1 > K2/L2 where K1 is the amount of capital utilized to produce good 1 etc. One major result within this model is the so-called Heckscher-Ohlin Theorem: à each country should export the good whose production is intensive in the relative abundant factor (ie. the relatively capital abundant country should export the capital intensive good – vice versa for the other country). à By doing so both countries gain from trade !! Differently from Ricardian model, here the patterns of trade are determined by differences in factor endowments - not productivity Remember, focus on relative advantage, not absolute advantage EMPIRICAL EVIDENCE Wassily Leontief in 1953 tested HO predictions for the USA According to him HO implies the following: (K/L)USA>(K/L)RW →(K/L)EXPUS>(K/L)IMPUS He found that: (K/L)EXPUS<(K/L)IMPUS This result became famous as the Leontief paradox!! GAINS FROM TRADE FOR ALL? We have seen that trade generates economic gains for the countries involved. But anedoctical evidence shows us that during and after a process of trade liberalization there are loosers. Trade theory predicts this outcome. Within the HO model there is a result (known as the Stolper- Samuelson Theorem) stating that when we open up to trade in a country the relative abundant factor will gain and the relatively scarse one will lose. For example, in trade between a rich country and a poor one, we can think that the former is relatively skilled labour abundant and the latter is unskilled labour abundant. The SS theorem predicts that as a consequence of trade liberalisation skilled workers will gain and unskilled workers will loose in the rich country (viceversa in the poor one). The SS theorem doesn’t contradicts the HO theorem. The latter says that the country overall will gain from trade, the former says that the distribution of these gain is so uneven to generate some loosers. The total gains of the gainers are bigger than the totall losses of the loosers. Empirical evidence has shown that the SS theorem prediction is only partially empirically correct (for a recent and simple presentation, see The Economist, 6 August 2016). TRADE AND INCOME DISTRIBUTION More recently economists (for ex. Autor, Dorn, Hanson – 2015) found that after the rise of China as a major player in international markets, it can be shown that international trade with China has generated income distribution effects in the US and contributed to the reduction in manufacturing employment. 1. Through its impact on economies of scale, trade can increase the variety of goods available to consumers and decrease the average cost of those goods • without trade, nations might not be able to produce those products where economies of scale are important • with trade, markets are large enough to support the production necessary to achieve economies of scale • so, trade is mutually beneficial because it allows for the specialization of production, the realization of scale economies, and the production of a greater variety of products at lower prices 2. In those industries when output required to attain economies of scale represents a significant proportion of total world demand, the global market may only be able to support a small number of enterprises • first mover advantages - the economic and strategic advantages that accrue to early entrants into an industry • economies of scale • First movers can gain a scale-based cost advantage that later entrants find difficult to match NEW TRADE THEORY AND INTRA-INDUSTRY TRADE INTRA-INDUSTRY TRADE New trade theory explains trade in similar products INTER-INDUSTRY TRADE (NEW TRADE THEORY) Ricardian and H-O models were able to explain mainly trade in different products New trade theory highlights additional sources of gains from trade: - pro-competitive effect: reduction in prices due to increased international competition - larger variety of products available for the consumers IMPLICATIONS OF NEW TRADE THEORY FOR NATIONS Nations may benefit from trade even when they do not differ in resource endowments or technology - a country may dominate in the export of a good simply because it was lucky enough to have one or more firms among the first to produce that good Governments should consider strategic trade policies that nurture and protect firms and industries where first mover advantages and economies of scale are important PORTER’S DIAMOND OF COMPETITIVE ADVANTAGE Michael Porter (1990) tried to explain why a nation achieves international success in a particular industry - identified four attributes that promote or impede the creation of competitive advantage 1. FACTOR ENDOWMENTS a nation’s position in factors of production necessary to compete in a given industry • can lead to competitive advantage • can be either basic (natural resources, climate, location) or advanced (skilled labor, infrastructure, technological know-how) 2.DEMAND CONDITIONS the nature of home demand for the industry’s product or service • influences the development of capabilities • sophisticated and demanding customers’ pressure 3.RELATING AND SUPPORTING INDUSTRIES the presence or absence of supplier industries and related industries that are internationally competitive • can spill over and contribute to other industries • successful industries tend to be grouped in clusters in countries 4. FIRM STRATEGY, STRUCTURE AND RIVALRY Firm strategy, structure, and rivalry - the conditions governing how companies are created, organized, and managed, and the nature of domestic rivalry • different management ideologies affect the development of national competitive advantage • vigorous domestic rivalry creates pressures to innovate, to improve quality, to reduce costs, and to invest in upgrading advanced features DOES PORTER’S THEORY HOLD? Government policy can - affect demand through product standards - influence rivalry through regulation and antitrust laws - impact the availability of highly educated workers and advanced transportation infrastructure. The four attributes, government policy, and chance work as a reinforcing system, complementing each other and in combination creating the conditions appropriate for competitive advantage So far, Porter’s theory has not been sufficiently tested to know how well it holds up APPLICATION OF PORTER’S IDEA Porter’s ideas have been applied to generate measures of country competitiveness. When applied to firm the concept of competitiveness is straightforward. Attention when you use it for a country (differently form a firm a country cannot go bankrupt). In this case the correct approach is to think of competitiveness as the set of conditions that favour economic growth. In the last 10 years a proper industry has emerged to measure competitiveness at the country level. The two most famous indices are those contained in the Global Competitiveness Report by the World Economic Forum (WEF) and The World Competitiveness Yearbook by IMD. MORE COMPETITIVE COUNTRIES BY INCOME GROUP: “COMPETITIVENESS” MATTERS FOR ECONOMIC GROWTH. In the report they generate a country ranking based on the Global Competitiveness Index This index is a weighted average of other indices, which are themselves weighted averages of publicly available hard data and information provided in the Forum’s Executive Opinion Survey. The Global Competitiveness Index is intended to measure factors that contribute to driving productivity and competitiveness. It is composed by 12 basic pillars (i.e. 12 subsets of economic variables) important The mercantilist philosophy makes a crude case for government involvement in promoting exports and limiting imports. Smith, Ricardo, and Heckscher-Ohlin promote unrestricted free trade. New trade theory and Porter’s theory of national competitive advantage justify limited and selective government intervention to support the development of certain export-oriented industries. WHAT IS MERCANTILISM? Mercantilism (mid-16th century) suggests that it is in a country’s best interest to maintain a trade surplus -to export more than it imports. This theory advocates government intervention to achieve a surplus in the balance of trade Mercantilism views trade as a zero-sum game - one in which a gain by one country results in a loss by another. However, in 1752, David Hume pointed out that: • Increased exports lead to inflation and higher prices • Increased imports lead to lower prices Result: Country A sells less because of high prices and Country B sells more because of lower prices. In the long run, no one can keep a trade surplus and the trade balance will balance. NEW VERSION: Export is good because it increases production and more jobs are created, while import is bad because it reduces my production and jobs are lost. What is Smith’s theory of absolute advantage? Adam Smith (1776) argued that a country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it Therefore, countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for goods produced by other countries. How does the theory of absolute advantage work? 2 countries: Ghana is better in producing cocoa (it has an absolute advantage in producing cocoa), while South Korea is better at producing rice (it has an absolute advantage in producing rice). Assume that two countries, Ghana and South Korea, both have 200 units of resources that could either be used to produce rice or cocoa In Ghana, it takes 10 units of resources to produce one ton of cocoa and 20 units of resources to produce one ton of rice. Ghana could produce 20 tons of cocoa and no rice, 10 tons of rice and no cocoa, or some combination of rice and cocoa between the two extremes In South Korea it takes 40 units of resources to produce one ton of cocoa and 10 resources to produce one ton of rice. South Korea could produce 5 tons of cocoa and no rice, 20 tons of rice and no cocoa, or some combination in between. Without trade: - Ghana would produce 10 tons of cocoa and 5 tons of rice - South Korea would produce 10 tons of rice and 2.5 tons of cocoa With specialization and trade - Ghana would produce 20 tons of cocoa ¬South Korea would produce 20 tons of rice - Ghana could trade 6 tons of cocoa to South Korea for 6 tons of rice After trade - Ghana would have 14 tons of cocoa left, and 6 tons of rice - South Korea would have 14 tons of rice left and 6 tons of cocoa - If each country specializes in the production of the good in which it has an absolute advantage and trades for the other, both countries gain ¬trade is a positive sum game In the table we have: RICARDO’S THEORY OF COMPARATIVE ADVANTAGE David Ricardo asked what happens when one country has an absolute advantage in the production of all goods The theory of comparative advantage (1817) - countries should specialize in the production of those goods they produce most efficiently and buy goods that they produce less efficiently from other countries - Even if this means buying goods from other countries that they could produce more efficiently at home BASIC ASSUMPTIONS: - 2 countries - 2 products - 1 factor of production (labor) - countries identical in all respect, but for differences in relative labor productivity - perfect competition in all markets - labor perfectly mobile across sectors within a country, but immobile internationally ASSUME - Ghana is more efficient in the production of both cocoa and rice - In Ghana, it takes 10 resources to produce on ton of cocoa and 13 1/3 resources to produce one ton of rice - So, Ghana could produce 20 tons of cocoa and no rice, 15 tons of rice and no cocoa, or some combination of the two - In South Korea, it takes 40 resources to produce one ton of cocoa and 20 resources to produce one ton of rice - So, South Korea could produce 5 tons of cocoa and no rice, 10 tons of rice and no cocoa, or some combination of the two WITH TRADE - Ghana could export 4 tons of cocoa to South Korea in exchange for 4 tons of rice - Ghana will still have 11 tons of cocoa, and 4 additional tons of rice - South Korea still has 6 tons of rice and 4 tons of cocoa - if each country specializes in the production of the good in which it has a comparative advantage and trades for the other, both countries gain Comparative advantage theory provides a stronz rationale for encouraging free trade - total output is higher - both countries benefit Trade is positive sum game - free trade may ultimately result in lower wages in the rich country The ability to offshore services jobs that were traditionally not internationally mobile may have the effect of a mass inward migration into the United States, where wages would then fall But, protectionist measures could create a more harmful situation than free trade CAUSES OF INTERNATIONAL TRADE 3- differences among countries à PRINCIPLE OF COMPARATIVE ADVANTAGES § RICARDO: difference relative labour productivity § HECKSCHER-OHLIN (H-O): difference relative factor endowments/abundacy 4- Imperfect competition + increasing returns to scale § MONOPOLY COMPETITION (Krugman, Helpman, Grossman) § OLIGOPOLY (Brander, Krugman) HECKSCHER-OHLIN THEORY Eli Heckscher (1919) and Bertil Ohlin (1933) - comparative advantage arises from differences in national factor endowments. The extent to which a country is endowed with resources like land, labor, and capital. The more abundant a factor, the lower its cost. In this model same hps. as in Ricardian model, but for: - Existence of 2 factors of productions (K and L) - Countries differ in terms of relative factor endowment Some definitions: A country (the US) is relatively abundant in capital (K) if: (K/L)USA>(K/L)RW The production of a good (1) is capital intensive if: K1/L1 > K2/L2 where K1 is the amount of capital utilized to produce good 1 etc. One major result within this model is the so-called Heckscher-Ohlin Theorem: à each country should export the good whose production is intensive in the relative abundant factor (ie. the relatively capital abundant country should export the capital intensive good – vice versa for the other country). à By doing so both countries gain from trade !! Differently from Ricardian model, here the patterns of trade are determined by differences in factor endowments - not productivity Remember, focus on relative advantage, not absolute advantage EMPIRICAL EVIDENCE Wassily Leontief in 1953 tested HO predictions for the USA According to him HO implies the following: (K/L)USA>(K/L)RW →(K/L)EXPUS>(K/L)IMPUS He found that: (K/L)EXPUS<(K/L)IMPUS This result became famous as the Leontief paradox!! GAINS FROM TRADE FOR ALL? We have seen that trade generates economic gains for the countries involved. But anedoctical evidence shows us that during and after a process of trade liberalization there are loosers. Trade theory predicts this outcome. Within the HO model there is a result (known as the Stolper- Samuelson Theorem) stating that when we open up to trade in a country the relative abundant factor will gain and the relatively scarse one will lose. For example, in trade between a rich country and a poor one, we can think that the former is relatively skilled labour abundant and the latter is unskilled labour abundant. The SS theorem predicts that as a consequence of trade liberalisation skilled workers will gain and unskilled workers will loose in the rich country (viceversa in the poor one). The SS theorem doesn’t contradicts the HO theorem. The latter says that the country overall will gain from trade, the former says that the distribution of these gain is so uneven to generate some loosers. The total gains of the gainers are bigger than the totall losses of the loosers. Empirical evidence has shown that the SS theorem prediction is only partially empirically correct (for a recent and simple presentation, see The Economist, 6 August 2016). TRADE AND INCOME DISTRIBUTION More recently economists (for ex. Autor, Dorn, Hanson – 2015) found that after the rise of China as a major player in international markets, it can be shown that international trade with China has generated income distribution effects in the US and contributed to the reduction in manufacturing employment. However, trade with China is only one part, albeit relevant, of US international trade. A more comprehensive study by Feenstra et al. (2017) takes into account the global (all countries, all trade – manuf and services) evolution of US international trade and shows that thanks to international trade total employment in the US has increased. However, the fact that changes in the economic environment (opening to trade, in this case) generates gainers and loosers is not new. Think of technical change. Also innovations generate losers. Remember the Luddites during the British Industrial Revolution. Or, more recently, the impact of the technological revolution we are in. The next table shows the prediction for occupations with the largest job decline in the US. This table from the Bureau of Labour Statistic of US - Prediction they did for employment THE PRODUCT LIFE CYCLE THEORY The product life-cycle theory - as products mature both the location of sales and the optimal production location will change affecting the flow and direction of trade - proposed by Ray Vernon in the mid-1960s - At this time most of the world’s new products were developed by U.S. firms and sold first in the U.S. According to the product life-cycle theory ¬the size and wealth of the U.S. market gave U.S. firms a strong incentive to develop new products - Initially, the product would be produced and sold in the U.S. - As demand grew in other developed countries, U.S. firms would begin to export - Demand for the new product would grow in other advanced countries over time making it worthwhile for foreign producers to begin producing for their home markets U.S. firms might set up production facilities in advanced countries with growing demand, limiting exports from the U.S. As the market in the U.S. and other advanced nations matured, the product would become more standardized, and price would be the main competitive weapon - Producers based in advanced countries where labor costs were lower than the United States might now be able to export to the United States - If cost pressures were intense, developing countries would acquire a production advantage over advanced countries - Production became concentrated in lower-cost foreign locations, and the U.S. became an importer of the product • influences the development of capabilities • sophisticated and demanding customers’ pressure 3.RELATING AND SUPPORTING INDUSTRIES the presence or absence of supplier industries and related industries that are internationally competitive • can spill over and contribute to other industries • successful industries tend to be grouped in clusters in countries 4. FIRM STRATEGY, STRUCTURE AND RIVALRY Firm strategy, structure, and rivalry - the conditions governing how companies are created, organized, and managed, and the nature of domestic rivalry • different management ideologies affect the development of national competitive advantage • vigorous domestic rivalry creates pressures to innovate, to improve quality, to reduce costs, and to invest in upgrading advanced features DOES PORTER’S THEORY HOLD? Government policy can - affect demand through product standards - influence rivalry through regulation and antitrust laws - impact the availability of highly educated workers and advanced transportation infrastructure. The four attributes, government policy, and chance work as a reinforcing system, complementing each other and in combination creating the conditions appropriate for competitive advantage So far, Porter’s theory has not been sufficiently tested to know how well it holds up APPLICATION OF PORTER’S IDEA Porter’s ideas have been applied to generate measures of country competitiveness. When applied to firm the concept of competitiveness is straightforward. Attention when you use it for a country (differently form a firm a country cannot go bankrupt). In this case the correct approach is to think of competitiveness as the set of conditions that favour economic growth. In the last 10 years a proper industry has emerged to measure competitiveness at the country level. The two most famous indices are those contained in the Global Competitiveness Report by the World Economic Forum (WEF) and The World Competitiveness Yearbook by IMD. MORE COMPETITIVE COUNTRIES BY INCOME GROUP: “COMPETITIVENESS” MATTERS FOR ECONOMIC GROWTH. In the report they generate a country ranking based on the Global Competitiveness Index This index is a weighted average of other indices, which are themselves weighted averages of publicly available hard data and information provided in the Forum’s Executive Opinion Survey. The Global Competitiveness Index is intended to measure factors that contribute to driving productivity and competitiveness. It is composed by 12 basic pillars (i.e. 12 subsets of economic variables) important IMPLICATIONS OF TRADE THEORY FOR MANAGERS 4. Location implications - a firm should disperse its various productive activities to those countries where they can be performed most efficiently § firms that do not may be at a competitive disadvantage 5. First-mover implications - a first-mover advantage can help a firm dominate global trade in that product 6. Policy implications - firms should work to encourage governmental policies that support free trade § want policies that have a favorable impact on each component of the diamond WHAT IS THE BALANCE OF PAYMENTS? A country’s balance of payments accounts keeps track of the payments to and receipts from other countries for a particular time period - double entry bookkeeping - sum of the current account balance, the capital account and the financial account should be zero There are three main accounts 4. The current account records transactions of goods, services, and income, receipts and payments § current account deficit - a country imports more than it export § current account surplus – a country exports more than it import 5. The capital account records one time changes in the stock of assets 6. The financial account records transactions that involve the purchase or sale of assets § net change in U.S. assets owned abroad § foreign owned assets in the U.S. EU DOMESTIC MARKET —> market supply curve (S) obtained from a provider profit maximization —> market demand curve (D) obtained from a customer utility o a maximization 9% @ 9 Both are happy when they are on their curves. A = equilibrium (autarchy) —> if it's a CLOSE MARKET, Pa is the only possible price. There would be forces that bring price in equilibrium * With free trade, the difference is covered by imports * With free trade, the difference is exported (e.g. to South Korea) Y These cases are equilibrium in trade Piyr —> new international price to which | add a tariff Dr —> new domestic price ECONOMIC EFFECTS OF A TARIFF ON A BIG COUNTRY Pur t Mu igpra and Po? Memento cola QI iena Qs ft ImPy RT The only difference is that here the INTERNATIONAL PRICE DOES NOT CHANGE All the other effects are the same Who is the better/worse off after a tariff? WELFARE EFFECTS OF A TARIFF HOME FOREIGN CONSUMERS n (+)? meno te PRODUCERS + _ GOERVMENTS + x® THERE ARE ALWAYS LOSERS AND WINNERS ® We assume that the other government has NO REACTION (no retaliation) It's important to quantify the amount of the loss and the gain, by looking at SURPLUS NW : national welfare NW = Cw+ Pu + GW CW : consumers welfare PW : producers welfare NW = CS+ PS+ GR GW : government welfare ANW = ACS + APS + AGR CS : consumers surplus PS : producers surplus GR: government reserve A: variation <0 20 20 losses of consumers > gain of producers + government reserves it depends on the industry, they have to analyze it Ifwe remove the assumption of NO RETALIATION, we have to add to the results the losses of EXPORTERS. Therefore, the possibility that a tariff allows national welfare to increase, decreases. HOW DO GOVERNMENTS INTERVENE IN MARKETS? NON-TARIFF BARRIERS 2. Subsidies government payments to domestic producers 3. Subsidies help domestic producers a. compete against low-cost foreign imports b. gain export markets 4. Consumers typically absorb the costs of subsidies 3. Import Quotas restrict the quantity of some good that may be imported into a country § Tariff rate quotas - a hybrid of a quota and a tariff where a lower tariff is applied to imports within the quota than to those over the quota § A quota rent - the extra profit that producers make when supply is artificially limited by an import quota 4. Voluntary Export Restraints quotas on trade imposed by the exporting country, typically at the request of the importing country’s government § Import quotas and voluntary export restraints § benefit domestic producers § raise the prices of imported goods 5. Local Content Requirements demand that some specific fraction of a good be produced domestically § benefit domestic producers § consumers face higher prices 6. Administrative Policies bureaucratic rules designed to make it difficult for imports to enter a country § polices hurt consumers by limiting choice 7. Antidumping Policies aka countervailing duties - punish foreign firms that engage in dumping and protect domestic producers from “unfair” foreign competition § dumping - selling goods in a foreign market below their costs of production, or selling goods in a foreign market below their “fair” market value HOW HAS THE CURRENT WORLD TRADING SYSTEM EMERGED? Until the Great Depression of the 1930s, most countries had some degree of protectionism § Smoot-Hawley tariff (1930) After WWII, the U.S. and other nations realized the value of freer trade § established the General Agreement on Tariffs and Trade (GATT) - a multilateral agreement to liberalize trade In the 1980s and early 1990s protectionist trends emerged § Japan’s perceived protectionist (neo-mercantilist) policies created intense political pressures in other countries § persistent trade deficits by the U.S § use of non-tariff barriers increased After WWII, the U.S. and other nations realized the value of freer trade, and established the General Agreement on Tariffs and Trade (GATT) § The approach of GATT (a multilateral agreement to liberalize trade) was to gradually eliminate barriers to trade Very successful: § 19 original members grew to 164 (July 2016) § Represents more than 94% of world trade § Tariff reduction from 40% to 5% GATT/WTO One basic principle: Non-discrimination Two applications of this principle - Most favored nation clause - National treatment clause WHY DO WE NEED THE GATT/WTO? The creation of GATT allowed to solve a sort of prisoner’s dilemma. In fact, international negotiations can help avoiding a trade war. Consider the following This is a non-cooperative game. The only Nash equilibrium is “Protectionism-Protectionism” Note: both country would be better off in the “Free trade-Free trade” situation (prisoners’ dilemma), but this cannot be an equilibrium given the characteristics of this game. This example tries to mimic the trade war escalation between the two world wars. In this set up one can interpret the role of the GATT in terms of a change of the rules of the game: from a non-cooperative game to a cooperative one The Uruguay Round of GATT negotiations began in 1986 focusing on 1. Services and intellectual property going beyond manufactured goods to address trade issues related to services and intellectual property, and agriculture 2. The World Trade Organization it was hoped that enforcement mechanisms would make the WTO a more effective policeman of the global trade rules The WTO encompassed GATT along with two sisters’ agreements - the General Agreement on Trade in Services (GATS) - the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS) The WTO has emerged as an effective advocate and facilitator of future trade deals, particularly in such areas as services So far, the WTO’s policing and enforcement mechanisms are having a positive effect Most countries have adopted WTO recommendations for trade disputes WHAT IS THE FUTURE OF THE WORLD TRADE ORGANIZATION? The WTO has become a magnet for various groups protesting free trade § The current agenda of the WTO focuses on § the rise of anti-dumping policies § the high level of protectionism in agriculture § the lack of strong protection for intellectual property rights in many nations § continued high tariffs on nonagricultural goods and services in many nations The WTO launched a new round of talks at Doha, Qatar in 2001 § The agenda includes § cutting tariffs on industrial goods and services § phasing out subsidies to agricultural producers § reducing barriers to cross-border investment § limiting the use of anti-dumping laws THE DOHA ROUND The contrasts among the various countries have produced a series of failures at the Ministerial Meetings of Cancun (September 2003) and Hong Kong (December 2006). In July 2008 the negotiations failed again. After the December 2013 (Bali) and the December 2015 (Nairobi) Ministerial Meeting in Bali, the Round is formally still open. One of the tables on which the negotiation stalled has been that of agricultural liberalization. The European Union with the Common Agricultural Policy and the United States with their agricultural subsidies have opposed the request of substantial liberalization advanced by a group of emerging economies with a comparative advantage in that sector. WHAT DO TRADE BARRIERS MEAN FOR MANAGERS? Managers need to consider how trade barriers affect the strategy of the firm and the implications of government policy on the firm 1. Trade barriers raise the cost of exporting products to a country 2. Voluntary export restraints (VERs) may limit a firm’s ability to serve a country from locations outside that country 3. To conform to local content requirements, a firm may have to locate more production activities in a given market than it would otherwise Managers have an incentive to lobby for free trade, and keep protectionist pressures from causing them to have to change strategies WHAT IS THE STATUS OF REGIONAL ECONOMIC INTEGRATION IN EUROPE? Europe has two trade blocs 1. The European Union (EU) with 27 members (after Brexit....) 2. The European Free Trade Area (EFTA) with 4 members The map shows the countries in the EU, dividing them according to wheatear are in the eurozone or not, countries that have EU approval and not. WHAT IS THE EUROPEAN UNION? The devastation of two world wars on Western Europe prompted the formation of the EU Members wanted lasting peace and to hold their own on the world’s political and economic stage Forerunner was the European Coal and Steel Community (1951). The European Economic Community (1957) was formed at the Treaty of Rome with the goal of becoming a common market The Single European Act (1987) committed the EC countries to work toward establishment of a single market by December 31, 1992 was born out of frustration among EC members that the community was not living up to its promise Provided the impetus for the restructuring of substantial sections of European industry allowing for faster economic growth than would otherwise have been the case WHAT IS THE POLITICAL STRUCTURE OF THE EUROPEAN UNION? The main institutions in the EU include: 1. The European Council: the ultimate controlling authority within the EU 2. The European Commission: responsible for proposing EU legislation, implementing it, and monitoring compliance with EU laws by member states 3. The European Parliament: debates legislation proposed by the commission and forwarded to it by the council 4. The Court of Justice: the supreme appeals court for EU law WHAT IS THE EURO? The Maastricht Treaty committed the EU to adopt a single currency - Created the second largest currency zone in the world after that of the U.S. dollar - used by 19 of the 28 member states - Britain, Denmark and Sweden opted out - since its establishment January 1, 1999, the euro has had a volatile trading history with the U.S. dollar IS EURO A GOOD THING? Benefits of the euro - savings from having to handle one currency, rather - it is easier to compare prices across Europe, so firms are forced to be more competitive - gives a strong boost to the development of highly liquid pan-European capital market - increases the range of investment options open both to individuals and institutions Costs of the euro - loss of control over national monetary policy - EU is not an optimal currency area SHOULD THE EU CONTINUE TO EXPAND? Many countries have applied for EU membership - Ten countries joined in 2004 expanding the EU to 25 states - In 2007, Bulgaria and Romania joined bringing membership to 27 countries - In 2012 Croatia joined - Turkey has been denied full membership because of concerns over human rights EU has signed many free trade agreements. At the moment EU is negotiating with the US a free trade agreement: the Transatlantic Trade and Investment Partnership (TTIP) WHAT IS THE STATUS OF ECONOMIC INTEGRATION IN THE AMERICAS? There is a move toward greater regional economic integration in the Americas • The biggest effort is the North American Free Trade Area (NAFTA) (now UCMFTA) • Other efforts include the Andean Community and MERCOSUR • A hemisphere-wide Free Trade of the Americas is under discussion WHAT IS THE NORTH AMERICA FREE TRADE AGREEMENT? The North American Free Trade Area includes the United States, Canada, and Mexico - abolished tariffs on 99% of the goods traded between members - removed barriers on the cross-border flow of services - protects intellectual property rights - removes most restrictions on FDI between members - allows each country to apply its own environmental standards - establishes two commissions to impose fines and remove trade privileges when environmental standards or legislation involving health and safety, minimum wages, or child labor are ignored Supporters of NAFTA claimed that Mexico would benefit from increased jobs as low cost production moves south and will see more rapid economic growth as a result the U.S. and Canada would benefit from - access to a large and increasingly prosperous market the lower prices for consumers from goods produced in Mexico - low cost labor and the ability to be more competitive on world markets - increased imports by Mexico Critics of NAFTA claimed that - jobs would be lost and wage levels would decline in the U.S. and Canada - pollution would increase due to Mexico's more lax standards - Mexico would lose its sovereignty Who Was Right? Research indicates that NAFTA’s early impact was subtle, and both advocates and detractors may have been guilty of exaggeration NAFTA is credited with helping create increased political stability in Mexico Other Latin American countries would like to join NAFTA Under President Trump the agreement has been renegotiated and the new name is: UCMFTA WHAT IS THE ANDEAN COMMUNITY? The Andean Pact formed in 1969 using the EU model, had more or less failed by the mid-1980s was re- launched in 1990, and now operates as a customs union. Renamed the Andean Community in 1997 Signed an agreement in 2003 with MERCOSUR to restart negotiations towards the creation of a free trade area. What Is MERCOSUL? MERCOSUL originated in 1988 as a free trade pact between Brazil and Argentina, was expanded in 1990 to include Paraguay and Uruguay and in 2005 with the addition of Venezuela. May be diverting trade rather than creating trade, and local firms are investing in industries that are not competitive on a worldwide basis. Initially made progress on reducing trade barriers between member states, but more recently efforts have stalled WHAT IS THE CENTRAL AMERICAN TRADE AGREEMENT AND CARICOM? There are two other trade pacts in the Americas - the Central American Trade Agreement –(CAFTA, 2005) - to lower trade barriers between the U.S. and members - CARICOM (1973) - to establish a customs union Neither pact has achieved its goals yet In 2006, six CARICOM members formed the Caribbean Single Market and Economy (CSME) - to lower trade barriers and harmonize macro- economic and monetary policy between members WHAT IS FREE TRADE OF THE AMERICAS? Talks began in April 1998 to establish a Free Trade of The Americas (FTAA) by 2005 The FTAA was not established and now support from the U.S. and Brazil is mixed the U.S. wants stricter enforcement if intellectual property rights Brazil and Argentina want the U.S. to eliminate agricultural subsidies and tariffs If the FTAA is established, it will have major implications for cross-border trade and investment flows within the hemisphere would create a free trade area of 850 million people who accounted for nearly $18 trillion in GDP in 2008 WHAT IS THE STATUS OF ECONOMIC INTEGRATION IN ASIA? Various efforts at integration have been attempted in Asia, but most exist in name only § Association of Southeast Asian Nations (ASEAN) § Asia-Pacific Economic Cooperation (APEC) § RCEP § CPTPP ASSOCIATION OF SOUTHEAST ASIA NATIONS (ASEAN) The Association of Southeast Asian Nations (ASEAN, 1967) - currently includes Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand, Vietnam, Myanmar, Laos, and Cambodia - wants to foster freer trade between member countries and to achieve some cooperation in their industrial policies An ASEAN Free Trade Area (AFTA) between the six original members of ASEAN came into effect in 2003 In January 2010, ASEAN and China signed an FTA to create ACFTA a free trade area of 1,9 billion people ASIA-PACIFIC ECONOMIC COOPERATION (APEC) The Asia-Pacific Economic Cooperation (APEC) - has 21 members including the United States, Japan, and China - wants to increase multilateral cooperation - member states account for 55% of world’s GNP, and 49% of world trade Horizontal Direct Investment (HFDI) • FDI in the same industry abroad as company operates at home. (usually market seeking) Vertical Direct Investment (VFDI) (usually cost saving) • Backward - investments into industry that provides inputs into a firm’s domestic production (typically extractive industries) • Forward - investment in an industry that utilizes the outputs from a firm’s domestic production (typically sales and distribution) WHY DO FIRMS CHOOSE M&A vs GREENFIELD INVESTMENTS? Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments Firms prefer to acquire existing assets because • mergers and acquisitions are quicker to execute than greenfield investments • it is easier and perhaps less risky for a firm to acquire desired assets than build them from the ground up • firms believe that they can increase the efficiency of an acquired unit by transferring capital, technology, or management skills MODES OF ENTRY IN INTERNATIONAL MARKETS 1. Exporting 2. Licensing 3. Foreign Direct Investments - a firm invests directly in new facilities to produce and/or market in a foreign country Suppose you want to sell your product in a foreign market. Which mode of entry do you choose? WHY DOES FDI OCCUR INSTEAD OF EXPORTING OR LICENSING? The next framework is commonly utilized: EXPORTING producing goods at home and then shipping them to the receiving country for sale • exports can be limited by transportation costs and trade barriers • FDI may be a response to actual or threatened trade barriers such as import tariffs or quotas LICENSING granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells Internalization theory (aka market imperfections theory) suggests that licensing has three major drawbacks compared to FDI: • firm could give away valuable technological know-how to a potential foreign competitor • does not give a firm the control over manufacturing, marketing, and strategy in the foreign country • the firm’s competitive advantage may be based on its management, marketing, and manufacturing capabilities WHAT IS THE PATTERN OF FDI? Question: Why do firms in the same industry undertake FDI at about the same time and the same locations? Knickerbocker - FDI flows are a reflection of strategic rivalry between firms in the global marketplace - multipoint competition -when two or more enterprises encounter each other in different regional markets, national markets, or industries Vernon - firms undertake FDI at particular stages in the life cycle of a product Question: But, why is it profitable for firms to undertake FDI rather than continuing to export from home base, or licensing a foreign firm? Dunning’s eclectic paradigm - it is important to consider - location-specific advantages - that arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets - externalities - knowledge spillovers that occur when companies in the same industry locate in the same area WHAT DOES FDI MEAN FOR MANAGERS? HOW DOES FDI BENEFIT THE HOST COUNTRY? There are four main benefits of inward FDI for a host country 1. Resource transfer effects: FDI brings capital, technology, and management resources 2. Employment effects: FDI can bring jobs 3. Balance of payments effects: FDI can help a country to achieve a current account surplus 4. Effects on competition and economic growth: greenfield investments increase the level of competition in a market, driving down prices and improving the welfare of consumers can lead to increased productivity growth, product and process innovation, and greater economic growth WHAT ARE THE COSTS OF FDI TO THE HOST COUNTRY? Inward FDI has three main costs: 1. Adverse effects of FDI on competition within the host nation subsidiaries of foreign MNEs may have greater economic power than indigenous competitors because they may be part of a larger international organization. 2. Adverse effects on the balance of payments when a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments 3. Perceived loss of national sovereignty and autonomy decisions that affect the host country will be made by a foreign parent that has no real commitment to the host country, and over which the host country’s government has no real control HOW DOES FDI BENEFIT THE HOME COUNTRY? The benefits of FDI for the home country include 1. The effect on the capital account of the home country’s balance of payments from the inward flow of foreign earnings 2. The employment effects that arise from outward FDI 3. The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country WHAT ARE THE COSTS OF FDI TO THE HOME COUNTRY? 1. The home country’s balance of payments can suffer - from the initial capital outflow required to finance the FDI - if the purpose of the FDI is to serve the home market from a low cost labor location - if the FDI is a substitute for direct exports 2. Employment may also be negatively affected if the FDI is a substitute for domestic production But, international trade theory suggests that home country concerns about the negative economic effects of offshore production (FDI undertaken to serve the home market) may not be valid May stimulate economic growth and employment in the home country by freeing resources to specialize in activities where the home country has a comparative advantage HOW DOES GOVERNMENT INFLUENCE FDI? Governments can encourage outward FDI - government-backed insurance programs to cover major types of foreign investment risk Governments can restrict outward FDI - limit capital outflows, manipulate tax rules, or outright prohibit FDI Governments can encourage inward FDI - offer incentives to foreign firms to invest in their countries - gain from the resource-transfer and employment effects of FDI, and capture FDI away from other potential host countries Governments can restrict inward FDI - use ownership restraints and performance requirements HOW DO INTERNATIONAL INSTITUTIONS INFLUENCE FDI? Until the 1990s, there was no consistent involvement by multinational institutions in the governing of FDI Today, the World Trade Organization is changing this by trying to establish a universal set of rules designed to promote the liberalization of FDI WHAT DOES FDI MEAN FOR MANAGERS? Managers need to consider what trade theory implies about FDI, and the link between government policy and FDI The direction of FDI can be explained through the location-specific advantages argument associated with John Dunning However, it does not explain why FDI is preferable to exporting or licensing, must consider internalization theory A host government’s attitude toward FDI is important in decisions about where to locate foreign production facilities and where to make a foreign direct investment Firms have the most bargaining power when the host government values what the firm has to offer, when the firm has multiple comparable alternatives, and when the firm has a long time to complete negotiations HOW IS COUNTRY COMPETITIVENESS USUALLY MEASURED? The Real Effective Exchange Rate (some of you have seen this already during the IME course) - The rate of growth of per capita income - Synthetic indices (we have seen this already in a previous lecture) THE REAL EFFECTIVE EXCHANGE RATE (REER) At the firm level, for a product we can distinguish: • price competitiveness: this is determined by production costs, the profit margin and the exchange rate • non-price competitiveness: this involves design of product, quality, post-sale services etc. At the country level there is an analogy for price competitiveness. This can be thought as a measure of average price competitiveness of the domestically produced products. As a consequence, this measure gives a summary view of the average price competitiveness of a country’s products (ATTENTION: it is not a measure of country competitiveness in the Mercantilist meaning) The name of this measure for the bilateral case is: Real Exchange Rate (RER): RER = (P/P*)×E where: P = domestic price level; P*=foreign price level; E = nominal exchange rate (price of domestic currency in units of foreign currency). (note the link between RER and Purchasing Power Parity Law) A more utilized measure takes into account the average price competitiveness of a country products with respect to a large number of countries. It is the Real Effective Exchange Rate (REER): REER = weighted average of bilateral RER Where the weights take into account the relevance of a country as an export mkt and/or import mkt for the country of reference. Computation of REER can be different due to: - Number of trading partner countries - Weighting scheme adopted: simple or double weighting - Aggregator: usually arithmetic or geometric weighted average - Type of price adopted: GDP deflator, consumer prices, producer prices, unit labour costs [memo: ULC = cost of labour per unit of output produced = (W/LP), where W = total labour compensation per hour worked; LP = labour productivity] An application: Italian products have lost considerably price competitiveness in the last 10 years. Is this loss due to the introduction of the Euro? Analysis: let’s utilise the Italian REER based on unit labour costs in the manufacturing sector compared to that other leading European countries Both France and Germany experience a much better evolution. memo: the REER utilized is based on Unit Labour Cost which depends on labour compensation (+) and on labour productivity (-) The dynamics of the euro is not the major explanation of the worsening price competitiveness of Italian goods. During this period total labour compensation in Italy had a moderate evolution. On the contrary, a sharp deceleration of labour productivity growth has taken place in Italy. ECONOMIC GROWTH A different measure of country competitiveness is the rate of growth of the economy (in absolute and/or per capita terms). This measure is more in line with the “acceptable” definitions of country competitiveness. An application: relative slow rate of growth of the European economy with respect to that of the US especially after the second half of the ’90s (and up to 2008). After the WW II Europe converged to the US both in terms of GDP per capita and in terms of labour productivity (= GDP per hour worked). This catching-up pattern experienced two major breaks in the last 30 years: - Break 1: GDP per capita convergence ended after 1975 - Break 2: labour productivity convergence was reversed after 1995 There are two different interpretations for break 1: a) The glass is half empty (Sapir Report) b) The glass is half full (Blanchard) HALF EMPTY UE experienced: strong convergence in GDP per capita for 2 decades and a half weak convergence in the ’70s divergence after the first half of the ’90s EU GDP per capita in 1970 and in 2000 is the 70% of the US one HALF FULL This is true, but it is valid only for output per capita. The picture is much less negative when we consider output per hour worked: EU is approx 90% of the US one. The difference is due to the fact that European employees work less hours during the year. Δ%(GDP/Pop) = Δ%(GDP/Hours) + Δ%(Hours/Pop) GDP per capita growth = Hourly labour productivity growth + Hour worked per capita growth The difference is due to the fact the European employee work a smaller number of hours per year wrt to US citizens. For example, between 1970 and 2000 the number of hours worked per person decreased by 23% in France and increased by 26% in the US The Europeans have “decided” to increase leisure rather than income... But this is not the only explanation available GDP PER CAPITA: EXPANDED DECOMPOSITION ECONOMIC GROWTH • Blanchard’s explanation focus on the second term on the right (however, it’s decline explains only one third of the decline hours per capita) Other explanations: • Prescott (2004): all decline in hours per capita was caused by higher labour taxes in Europe • Ljungqvist-Sargent (2006): European welfare system increases unemployment and reduces labour force partecipation • Alesina, Glaeser, Sacerdote (2006): decline in hours is mainly due to the political pressure by trade unions and left-wing parties to reduce hours and lower the retirement age BREAK 2 But in the last 10 years European performance in terms of hourly labour productivity has not been good (break 2)....... .....probably because of the slower diffusion of information technologies and management practices matter! SYNTHETIC MEASURES A third way to measure is to create an index on the basis of may variables. The chosen variables are usually thought to influence economic growth. In the last 10 years a proper industry of these measure The two most famous indices are those contained in the Global Competitiveness Report by the World Economic Forum (WEF) and The World Competitiveness Yearbook by IMD. Porter’s ideas have been applied to generate measures of country competitiveness. When applied to firm the concept of competitiveness is straightforward. In this case the correct approach is to think of competitiveness as the set of conditions that favour economic growth. The two most famous indices are those contained in the Global Competitiveness Report by the World Economic Forum (WEF) and The World Competitiveness Yearbook by IMD. In a previous lecture we have seen the measure published by WEF.