International Economics ppt chapter five

International Economics best ppt note

1. CHAPTER FIVE TRADE, GROWTH AND DEVELOPMENT LEMMA SH.

2. Trade and development: Foreign Direct Investment (FDI) Foreign Direct Investment (FDI) refers to investment in a foreign country where the investor retains control over the investment. The investment made by a company in new manufacturing and/or marketing facilities in a foreign country is referred to as FDI . UNCTAD’s world investment report defines FDI as an investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy, in an enterprise resident in an economy other than that of the foreign direct investor. FDI is playing an increasing role in economic development. Economic reforms and the far-reaching political changes have resulted in very substantial changes in the international capital flows. FDI now contributes to a significant share of the domestic investment. 2

3. Forms of FDI Purchase of existing assets in a foreign country. New investments in property, plant, equipment. Participation in a joint venture with a local partner. Transfer of many assets like human resources, systems, technological know-how in exchange for equity in foreign companies. Export of goods for equity, 3

4. Factors influencing FDI Factors influencing FDI are of three categories: Supply factors: Production costs L ogistics Resource availability Access to technology Demand factors: Customer access M arketing advantages Exploitation of competitive advantages Customer mobility Political factors: Avoidance of trade barriers Economic development incentives 4

5. Reasons for FDI FDI is the ownership and control over assets held in foreign countries . This is because of the following reasons: Increase in sales and profits Enter rapidly growing markets Reduce costs Protect domestic markets Protect foreign markets Acquire technological and managerial know-how 5

6. Cost and Benefits of FDI FDI has its costs and benefits to the home country as well as host country . Benefits to Home country Costs to Home Country Benefits to Host country Costs to Host Country 6

7. Contd., Benefits to Home Country: Inflow of foreign currencies in the form of dividend, interests, etc., FDI increases export of machinery, equipment, technology, etc., The increased industrial activity in the home country enhances employment opportunities. Costs to Home Country: Home country’s industry and employment position are at stake when the firms enter foreign markets due to low cost labor Current account position of the home country suffers as FDI is a substitute for direct exports. 7

8. Contd., Benefits to Host country: Resource transfer effects Employment effects Balance of payments effects Cost to Host country: Intensifying competition Negative effects on the BOP 8

9. Implications of FDI for Business If the cost of transportation are minimum, it would be preferable for the companies to export. If the cost of transportation and trade barriers are significant, it would be preferable to go for FDI The firm can go for licensing if the know-how (technical skill and knowledge) is available . If the company’s skills and capabilities are not available for licensing, better the company go for FDI. 9

10. Multi- N ation E nterprise The basic necessary elements of a theory of multinational firms can best be seen by looking at an example. Consider the European operations of American auto manufacturers, Ford and General Motors, for example, sell many cars in Europe, but nearly all those cars are manufactured in plants in Germany, Britain, and Spain. This arrangement is familiar, but we should realize that there are two obvious alternatives. On one side, instead of producing in Europe the U.S. firms could produce in the United States and export to the European market . On the other side, the whole market could be served by European producers such as Volkswagen and Renault. 10

11. Contd., Why, then, do we see this particular arrangement, in which the same firms produce in different countries? The modern theory of multinational enterprise starts by distinguishing between the two questions of which this larger question is composed. First , why is a good produced in two (or more) different countries rather than one? This is known as the question of location . Second , why is production in different locations done by the same firm rather than by separate firms? This is known, for reasons that will become apparent in a moment, as the question of internalization . We need a theory of location to explain why Europe does not import its automobiles from the United States; we need a theory of internalization to explain why Europe's auto industry is not independently controlled. 11

12. Contd., Theory of location The location of production is often determined by resources . Aluminum mining must be located where the bauxite is, aluminum smelting near cheap electricity. Minicomputer manufacturers locate their skill-intensive design facilities in Massachusetts or northern California and their labor-intensive assembly plants in Ireland or Singapore. Alternatively , transport costs and other barriers to trade may determine location. American firms produce locally for the European market partly to reduce transport costs ; since the models that sell well in Europe are often quite different from those that sell well in the United States, it makes sense to have separate production facilities and to put them on different continents. As these examples reveal, the factors that determine a multinational corporation's decisions about where to produce are probably not much different from those that determine the pattern of trade in general. 12

13. Contd., The theory of internalization is another matter. Why not have independent auto companies in Europe? We may note first that there are always important transactions between a multinational's operations in different countries. The output of one subsidiary is often an input into the production of another . Or technology developed in one country may be used in others . Or management may usefully coordinate the activities of plants in several countries . These transactions are what tie the multinational firm together , and the firm presumably exists to facilitate these transactions. But international transactions need not be carried out inside a firm . Components can be sold in an open market, and technology can be licensed to other firms . Multinationals exist because it turns out to be more profitable to carry out these transactions within a firm rather than between firms . This is why the motive for multinationals is referred to as " internalization ." 13

14. Trade strategy There are two types of trade strategies: In-ward looking strategy (Import substitution) and Out-ward looking strategy (Export promotion). Import substitution policies Protect import competing manufacturing sectors through active trade policy – limit imports Import substitution involves extensive use of trade barriers to protect domestic industries from import competition. Practiced since 1930s Justifications: Infant industry argument Market failures argument 14

15. Cont’d., Export Promotion and Export Led Growth Focus on areas of comparative advantage (exports) rather than areas of comparative disadvantage (imports) Viewpoint since the mid 1960s– critique of import substitution Has taken a strong hold in development policy since early 1990s Based on promotion of exporting industries, rather than protection of import competing industries The trade strategy of a nation has impact not only on the volume and composition of foreign trade, but also on the pattern of investment and direction of development, entrepreneurial and business behavior, consumption pattern, etc. 15

16. Trade & Development Model In this concept we shall start with a simple comparative-static exercise to illustrate the effect of growth on the terms of trade between a rich and a poor country. Then, we analyze the pro-competitive effect of trade liberalization on output expansion in the context of imperfect competition and a vertical industrial structure . Finally , we briefly assess the implications of the recent literature on endogenous growth in an open economy. 16

17. Contd., In order to concentrate on some specific determinants of the terms of trade between a rich and a poor country. in a simple comparative-static framework , we abstract from many other aspects and assume that both countries are completely specialized. the poor country producing and exporting only a primary product m and the rich country only a manufactured product c . The trade deficit D, for the poor country is then given by 17

18. Contd., where zc is per capita import of c in the poor country xm is export of m by the poor country per person in the rich country L and y are the population and per capita income , respectively, in the poor country. the same variables with over bars represent those for the rich country, and p is the commodity terms of trade for the poor country . The demand for imports in each country (the import in the rich country is what the poor country exports) depends on per capita income in that country, and on the relative price of the relevant good. We take, not unrealistically in most cases, the trade deficit of the poor country to be non-negative. 18

19. Contd., One of the ways in which the import substitution regime is supposed to hurt the economy in poor countries is by blocking the discipline of international markets on domestic production efficiency . Although there are not too many theoretical models spelling out the exact analytical mechanism , the pro-competitive effect of trade liberalization on output expansion is part of the conventional wisdom of the trade literature . In the context of developing countries, where the domestic market in the industrial sector is often highly imperfect and fixed costs are significant, and where much of the imports provide the vital industrial inputs, one can make a special case for the beneficial pro-competitive effects of trade liberalization in those inputs. 19

20. Thank You ! 20