CHAPTER T W E L V E
12 International
Economics
Eleventh Edition
International Resource Movements
and Multinational Corporations
Dominick Salvatore
John Wiley & Sons, Inc.
Types of international resource
movement
International investment flows
Portfolio investment
Direct investment and multinational
corporations
International labor migration
Multinational Corporations
Multinational Corporations (MNCs),
Multinational Enterprises (MNEs), Transnational
Corporations (TNCs):
A corporation or enterprise that manages
production establishments or delivers services
located in at least two countries
MNCs comprise parent enterprises and their
foreign affiliates.
A parent enterprise is defined as an enterprise that
controls assets of other entities in countries other
than in its home country, usually by owning a
certain equity capital stake.
Multinational Corporations
An equity capital stake of 10% or more of the ordinary
shares or voting power for an incorporated enterprise,
or its equivalent for an unincorporated enterprise, is
normally considered as the threshold for the control of
assets.
However, in some countries, an equity stake threshold
of other than 10% is still used: In the United Kingdom,
for example, a stake of 20% or more was the threshold
used until 1997.
A foreign affiliate is an incorporated or
unincorporated enterprise in which an investor, who is
a resident in another economy, owns a stake that
permits a lasting interest in the management of that
enterprise.
Foreign Direct Investment
Foreign Direct Investment (FDI):
Investment involving a long-term relationship and
reflecting a lasting interest and control by a resident
entity in one economy (foreign direct investor or parent
enterprise) in an enterprise in an economy other than
that of the foreign direct investor
FDI implies that the investor exerts a significant degree
of influence on the management of the enterprise
resident in the other economy.
Such investment involves both the initial transaction
between the two entities and all subsequent
transactions between them and among foreign affiliates.
Portfolio Investment
Portfolio Investment:
It occurs when an individual or financial institution
buys a relatively small number of shares in a
company located in another country because of the
expectation that those shares will appreciate in
value and can be sold at a profit sometime in the
future.
The investor in this case has no influence over
management decisions and no long-term
commitment to the company.
Reasons for portfolio
investment
As substitute for international trade:
The factor price equalization theory shows that
factor returns should equalize after free trade.
Full free trade may not occur.
Non-tradable goods
Transactions costs
Government restrictions on trade
Therefore, factor price equalization is unlikely
to occur.
Portfolio investment takes advantage of the
higher returns available in some nations. 7
Reasons for portfolio
investment
As substitute for international trade
Risk diversification
Portfolio theory demonstrates that investing in
securities with yields that are uncorrelated over
time offers an identical return at lower risk than
investing in securities with correlated yields.
8
Reasons for direct investment
Internalize the returns to intellectual
property
Exploit economies of scale
Avoidance of trade restrictions
9
Key Concepts: Types of MNCs
Horizontal vs. Vertical Integration (MNCs)
Horizontal integration: The MNC produces broadly the
same line of goods in each geographic market where it
operates.
It involves the production abroad of a differentiated
production that is also produced at home.
Vertical integration: The MNC produces outputs in
some of its plants that serve as inputs to its other
activities.
It involves the expansion of a firm backward to
supply its own raw materials and intermediate
products and/or forward to provide its own sales or
distribution networks.
Key Concepts: Types of MNCs
Diversified MNCs: The MNC is the diversified
company whose plants’ outputs are neither
vertically nor horizontally related to one another.
Since foreign investment is a risky activity, an
MNC could diversify its risks by investing across
countries.
Stylized Facts of MNCs and FDI
Fact 1: FDI grew dramatically in the last 20 years, far
outpacing the growth of trade and income.
Source: World Investment Report, 2021 (UNCTAD)
Stylized Facts of MNCs and FDI
Fact 1: (cont.)
The periods of 1986-2000 and 2003-2007 saw an
enormous growth of activity by MNCs, as measured
by flows of FDI.
Inflows of FDI grew much faster than either trade or
income.
Despite their rapid growth, FDI flows remain much
smaller than trade flows.
2020: Due to COVID-19, global FDI flows fell by 35% in
2020, which is the lowest level since 2005.
Stylized Facts of MNCs and FDI
Fact 2: FDI originates predominantly from advanced
countries.
The predominant source of supply of FDI is the
advanced countries: EU15 (Austria, Belgium, Denmark,
Finland, France, Germany, Greece, Ireland, Italy,
Luxembourg, The Netherlands, Portugal, Spain, Sweden,
United Kingdom), Iceland, Norway, Switzerland, Canada,
the United States, Australia, New Zealand, and Japan.
Among individual countries, the U.S. is the world’s
largest foreign investor.
In the developing world, only the Asian countries
(especially China, Hong Kong, Taiwan, Korea, and
Singapore) supply a significant share of world flows.
Stylized Facts of MNCs and FDI
Fact 2: (cont.)
Source: World Investment Report, 2021 (UNCTAD)
Stylized Facts of MNCs and FDI
Fact 2: (cont.)
The EU as a whole accounted for 70% of all outward
stocks, and its share has risen sharply partly because of
the rise in intra-EU investments associated with
deepening integration in the EU and following the
creation of the Single Market in 1992.
Notice that the EU’s FDI is exaggerated relative to
the US FDI, as intra-US investments are classified as
domestic investments.
In the developing world, only the Asian countries
(especially China, Hong Kong, Taiwan, Korea, and
Singapore) supply a significant share of world flows.
Stylized Facts of MNCs and FDI
Fact 3: In the past, FDI went predominantly to
advanced countries, but the share of developing
countries has been rising.
The destination of FDI: Most FDI inflows went to
the advanced countries in the past.
It is not surprising because MNCs often seek large
and growing markets.
As for developing countries, the share of worldwide
FDI received by the developing and transition
economies jumped from 24.6% in the period of 1988-93
to more than 50% in recent years (55 % in 2014).
Stylized Facts of MNCs and FDI
Fact 3: (cont.)
Source: World Investment Report, 2021 (UNCTAD)
Stylized Facts of MNCs and FDI
Fact 3: (cont.)
These flows go overwhelmingly to Asia and Latin
America, and China alone took around one-quarter of
the total.
The increase of FDI flows to developing countries
reflects the growing importance of FDI as a source of
financing of these economies.
Stylized Facts of MNCs and FDI
Fact 4: Greenfield projects account for the greater share
of FDI flows over mergers and acquisitions (M&As),
especially to high-income countries, after the global
financial crisis of 2008-09.
The establishment of a foreign subsidiary may take
place in one of two ways.
Either as a ‘green-field investment’, where a new
plant is set up from scratch, or as a merger with or
acquisition of an existing firm (M&A).
The majority of FDI takes place through greenfield
investment rather than through M&A activities.
Stylized Facts of MNCs and FDI
Fact 4: (cont.)
Source: World Investment Report, 2021 (UNCTAD)
Stylized Facts of MNCs and FDI
Fact 5: Most FDI flows are concentrated in skill- and
technology-intensive industries.
The most noticeable trend in the sectoral
distribution of FDI stocks in the OECD countries is the
increase in the share of services and the parallel
decline of the primary sector.
This trend reflects the overall shift of world GDP
from the primary sector and agriculture towards
services.
Within manufacturing, the largest shares are in
chemicals, electrical and electronic equipment,
transport equipment, etc.
Stylized Facts of MNCs and FDI
Fact 5: (cont.)
Source: World Investment Report, 2019 (UNCTAD)
Stylized Facts of MNCs and FDI
Fact 6: MNCs are larger and sometimes more
productive than national firms.
MNCs are generally large companies compared
with national firms, both in home and host countries.
Foreign subsidiaries of MNCs are more productive
than local companies.
The home activities of MNCs are also more
productive than those of national firms.
Stylized Facts of MNCs and FDI
Fact 7: MNCs are increasingly engaged in
international production networks.
According to a research done by the WTO, the
‘American’ car:
30% of the car’s value goes to Korea for assembly,
17.5% to Japan for components and advanced
technology, 7.5% to Germany for design, 4% to Taiwan
and Singapore for minor parts, 2.5% to the UK for
advertising and marketing services, and 1.5% to
Ireland and Barbados for data processing.
Only 37% of production value is generated in the
U.S.
Issues of MNCs and FDI
Issue 1: Why do firms become multinational?
There are two distinct aspects to multinationality.
The first is the geographic dispersion of the firm’s activities:
multinationals have operations in many countries, although the
nature of these operations varies widely, from raw materials
processing to final product assembly.
The other is the concentrated ownership, or internalization,
of these activities: a firm that decides to operate in a foreign
country can do it in different ways, for example, by opening a
subsidiary or by subcontracting to local firms.
Issues of MNCs and FDI
Issue 2: Why do MNCs go to some countries and not
to others?
We saw from stylized facts that multinational activity is
very unevenly distributed across countries, and also that the
geographical pattern of investments has changed in recent
years.
Answering this question is important to the understanding
of how some developing countries have been able to grow fast
on the basis of successful integration into the world economy,
while others appear to have been marginalized.
Issues of MNCs and FDI
Issue 2 (cont.)
If countries are to be able to design policies to attract
investments, then clearly it is necessary that they understand
the forces shaping these locational choices.
Legal system to protect property rights of foreign investors
Access to a large market
Trade barriers
Availability of cheap factors of production
Issues of MNCs and FDI
Issue 3: What is the effect of MNCs on host
economies?
Many commentators regard MNC investments as a source
of benefits, bringing inflows of capital and technology and
creating new job opportunities.
Others see multinational activity as undermining local
firms, threatening economic instability and undermining local
government.
As usual, careful economic modeling and empirical work
are needed to form a judgment about the importance of these
effects.
Role of knowledge spillovers
Issues of MNCs and FDI
Issue 4: What is the effect of MNCs on home
economies?
The issue is equally controversial.
Countries may benefit from being the home of large MNCs,
but question the effects of their firms transferring part of their
activities to another country.
Once again, careful economic modeling and empirical work
are needed to form a judgment about the importance of these
effects.
Manufacturing sector: Hollowing-out Effect
Issues of MNCs and FDI
Issue 5: What are the implications for policy?
The link between MNCs and policy is multifaceted.
The presence of MNCs may change the effectiveness of
domestic policies and may create incentives for new policy
measures.
Policies may be designed to attract (or discourage) MNC
activities.
Many areas of policy, from taxes through trade policy, labor
market regulations and the legal system, alter the
attractiveness of a country as a host for inward investment.
Reasons for labor migration
The opportunity to earn higher wages
Greater educational opportunities
Escape from political oppression or conflict
Costs of labor migration
Monetary costs of migration
Lost wages
Payment for transportation
Payment of fees for entry
Non-monetary costs of migration
Loss of family
Need to acculturate to new surroundings
Effects of labor migration
Effects on recipient country
Increased ability to produce
The increase in the labor force increases
productive ability by expanding one of the
factors of production.
The workers may possess high levels of skills
that enhance the recipient country’s human
capital.
H1-B visas in the U.S. target just such workers.
In the United States, immigrants account for more
than half of all STEM (science, technology,
engineering, and math) workers with PhDs.
(Hanson and Slaughter, NBER Working Paper 2016)
Effects of labor migration
Effects on recipient country
Increased ability to produce
Dislocation of native workers competing
with the new entrants to the labor force
Increased unemployment
Lower wages
Effects of labor migration
Effects on recipient country
Increased ability to produce
Dislocation of native workers competing
with the new entrants to the labor force
Improved return to capital
Effects of labor migration
Effects on the source country
Loss in domestic productive ability
The decrease in the labor force decreases the
nation’s ability to produce.
This concern is reduced if the source country suffers
from significant unemployment.
The loss of skilled workers – a brain drain –
reduces human capital.
This concern is exacerbated by the resources
expended in training such workers prior to
migration.
Effects of labor migration
Effects on the source country
Loss in domestic productive ability
Increased domestic wages
The decline in the number of workers should
aid in driving up wages in the source country.
Again, this effect is reduced if the country
suffers significant unemployment.
Effects of labor migration
Effects on the source country
Loss in domestic productive ability
Increased domestic wages
A new source of foreign earnings: repatriated
income
