10 The economics of multinational firms and FDI

Enterprise that controls and manages production establishments (plants) located in at least two countries

Equity capital + reinvested earnings + other capital associated w/ intercompany debt transaction (10% equity stake requirement)

—> might not be a good proxy for MNE activity

Investment made to acquire interest in enterprises operating outside of the investor’s economy

Investor seeks to gain effective voice in management of the enterprise (10% equity as threshold for FDI)

1. high R&D to sales ratio

2. high white collar workers ratio

3. high value of intangible assets

4. older & established

5. associated with technically complex & new products

6. associated with product differentiation variables

7. negatively associated with plant-level scale of economics

8. size threshold important to become MNE, above unimportant

1)          Ownership advantage: firm must have product or production process such that it has market power advantage in foreign markets

2)         Location advantage: firm must have reason to want to locate production abroad rather than concentrate it in home country (esp. if there are scale economies at plant level)

3)         Internalization advantage: firm must have reason to want to exploit its ownership advantage internally rather than license or sell product/process to foreign firm

• Market seeking (horizontal): Choice: exporting to vs. producing in foreign country

• Cost saving (vertical): Choice: integrated production at home vs. fragmented production abroad

—> Define costs and benefits of producing abroad vs. at home —> understanding the trade-offs

• Economies of Scale foregone

  • Firm level economies of scale

  • Plant level economies of scale

    • increasing cost of operating with many plants

• Economies of Integration foregone

  • Technical inefficiencies in breaking up value added chains

  • Trade costs (freight, time, trade barriers)

Factor cost reduction:

• access to cheaper inputs

  • Labour

  • R&D

  • Primary Inputs

• quality, not just price

• Factor endowments of host countries vs. factor content of stages of production

• Firm has no market power:

  • Prices are given

  • Minimizing cost = maximizing profits

• Final output constant and equal 1

• Problem of the firm:

  • Choose location in order to minimize costs of production