Economics Department

University of Chulalongkorn

Bangkok, Winter 2000, Part II Micro

Professor James Gander(Bangkout.200, University of Utah, USA)

Title of Course: International Economics Investment, Part II.

Texts: R. Caves, Multinational Enterprise and Economic Analysis, 2nd. ed. 1996

Optional Material:

UNCTAD, World Investment Report 1996 (WIR96)

UNCTAD, World Investment Report 1997 (WIR97)

UNCTAD, World Investment Report 1999 (WIR99)

Outline:

General Description: Part II continues the theory and policy of international economics investment laid down by Professor Reynolds in Part I, but with a microeconomics orientation. The main economic tools come from the theory of the firm, particularly the theories of production, cost, investment, and demand, and the theory of market structures (the industrial organization approach). Students should access the internet web site for Part II of the course under, www.econ.utah.edu. A large part of the course will focus on economic analytical models. Empirical work will consider the determinants of firm performance in the international investment arena. The assigned readings give a broad background of the subject matter. Many of the readings will not be covered directly during the class meetings due to the compressed nature of the course format. However, students should at least attempt to sample the readings in order to participate in class discussions.

Topics:

1. General overview of multinational enterprises (MNEs).

The global matrix of countries and trade links, foreign direct investment (FDI) links, and foreign portfolio equity investment (FPEI) links (see link).

Top 100 MNEs for 1997 in developed countries.

Top 50 MNEs for 1997 in developing countries.

The 100 largest US MNEs for 1995.

The role of MNE's in Asian Financial Crisis 1997-98.

See, WIR 1999, Chapter VI and appendixes and Annex Table B.1; Forbes July 15, 1996; Readings 1-3 and 9-11.

2. Microeconomics of MNEs and tools of analyses.

The multiplant firm and plant location in world (see link).

Cost curves and economies of scope.

General theory of investment.

Coase and firm's boundary.

Transaction costs and internalization.

Types of MNEs and Dunning's L.O.I. model:

Horizontal plants and LOI advantages

Vertical plants (the make or buy model).

Diversified plants (spreading risk mean-variance model).

Proprietary assets: the motive for investment, the limit, and the means and location of MNEs in world.

See, any text on intermediate microeconomics.

See, R. Caves, chp 1.

See, readings #5 and #6 and #15.

3. MNEs and FDI flows.

MNE as arbitrager (buy low/sell high) of equity capital; equalize rates of return hypothesis.

Hypothesis neither necessary nor sufficient to explain FDI:

MNE and perfect competition not compatible

Arbitrage equalizes risk-adjusted rates of return

Profit return compensates for risk premium.

Foreign investment under uncertainty model (probability of bad times vs good times, see link).

Export (intra firm) vs FDI (subsidiary production) model (see link):

Effect of economies of scale

Effect of tariffs and taxes

Effect of industry structure.

See, Caves, chp 2.

4. Internal firm organization and growth of MNEs.

Penrose theory of firm growth.

Proprietary asset (p-asset) model (Arrow, learning by doing).

Internal organizational structure of the firm:

Single unit vs multi units

Information, communication, decisions

Centralization vs decentralization (product, geographic)

Geographic profit segments or centers of US firms.

Expansion by new ventures (Greenfield) vs acquisitions vs joint ventures:

Risk and coordination cost affects choice

Strategic motives for acquisition (block rival's entry).

Model: probability of entry by acquisition depends on geographic diversification, product diversification, nondurable vs durable product, relative size of acquisition to parent's size, cultural distance, host government policies, market maturity and uncertainty, number of other ties and links for sharing.

Model: administrative cost of coordination (adm/employ) depends on firm size, foreign intensity of operations, type and number of subsidiaries, market share, geog diversity, prod diversity, rivalry or competition.

See, Caves, chp 3, also, reading #15 again and #17.

5. Theory of market structures and patterns of competition.

A. Theory of market structure:

Basic industrial organization (hereafter, I/O) approach.

Definitions and relationships for structure, conduct, and performance.

Cournot oligopoly behavior in closed and open economy (see link).

Contestable market theory applied to multinational enterprise (hereafter, MNE).

General theory of market entry (foreign vs. domestic) and two- stage game for demand and capital (see link).

B. FDI effect on host industry structure, conduct, and performance:

Barriers to entry, concentration and MNEs-empirical relationships, direction of causation for FDI and CR.

Knickerbocker's bunching model (early bunching of entry).

Mutual dependency among MNEs: vertical and horizontal competition (Zeuthen's model, see link).

Profit performance of MNEs-empirical relationship.

MNEs and national welfare and policy: goal of competitive domestic markets (price equals marginal cost) and maximum rent extraction from exports (marginal revenue equals marginal cost) and from imports (marginal revenue product equals marginal outlay)-illustrated with monopoly/monopsony model.

Vertically integrated MNEs and stages of competition for rents (Zeuthen model and formulae, see same link again).

C. FDI and FPEI linkage:

Overview again of the financial crisis in South East Asia.

Balance of Payments and FDI and FPIE identity (see link).

Empirical data on flows.

Theory and linkages between the two.

Development of a securities market, problem of disclosure and capitalism without risk.

See, S. Martin, chp 13, Industrial Economics and International Trade, reading #13, also WIR99, Chapter VI.

W. Shepherd, chp 1, Basic Concepts, Introduction, reading #12.

Caves, chp 4, Text.

WIR(97), reading #7, chapter 4 on the effect of FDI on the structure of host and home industries.

Knickerbocker, Oligopolistic Reaction and MNE, chp1 product- life cycle, chp 2 measurement of ECI, and chp 3 oligopoly reactions, reading #14.

FPEI, reading #16 and again readings 1-3 and 9-11.

6. Survey of theories explaining MNE (more detailed).

Locational advantages of foreign direct investment (hereafter, FDI).

Horizontal multiplant firms and transaction-cost advantage of internal control, the Coase theorem on size of firm and proprietary assets (trade secrets, skills, brand recognition, and intangible assets) (see link).

Vertical integration and transaction-cost advantages (contract costs, monitoring costs, dispute resolution costs).

Portfolio diversification (conglomerate firm) approach and risk reduction.

Dunning's Eclectic Model (Ownership, Location, Internalize).

See, Caves, chp1, text.

John Dunning, Multinationals, Technology and Competitiveness, 1988, chps 1 and 2 (OLI model), readings #5 and #6.

Read also, Executive Summary, World Investment Report 1996.

For eclectic model, read, J. Dunning, International Production

and the Multinational Enterprise, 1981, chp 3.

7. Motives and determinants of foreign production (investment).

Motives for foreign production (natural resource seekers, market seekers, efficiency seekers, strategic asset seekers to enhance long-term goals and competitive position).

Determinants of foreign direct investment (empirically significant factors).

See, John Dunning, Multinational Enterprises and the Global

Economy, 1993, chp 3, reading #5.

UNCTC, The Determinants of Foreign Direct Investment: A

Survey of the Evidence, 1992, reading #8.

8. Summary of selected empirical models.

The following studies are mentioned in Caves and are for your reading. Some will be surveyed in the classroom. Pay particular attention to the data, model or methodology, and results.

A) Knickerbocker (1973), Oligopolistic Reaction and MNE: chps 1,2, and 3, bunching of oligopoly firms and entry concentration index (ECI). Index formed by measuring the number of subsidiaries formed in a given industry by US firms over 3-5-7 years compared to a twenty-year period as a quadratic function of the concentration ratio CR4 in home industry. Reading #14.

B) S. Lall (1981), "Monopolistic Advantages and Foreign Involvement by U.S. Manufacturing Industry," OEP, March: Exams for 25 2- and 3-digit industries, share of affiliate sales plus exports from the US in US industry total production and share of affiliate sales in total US industry production, on RND intensity, AD intensity, KL intensity, SCALE, SALARIED employees as share of total work force in each industry, PW average wage per production work, AW average wage per employee.

C) T. Pugel (1981), "The Determinants of Foreign Direct Investment: An Analysis of US Manufacturing Industries," MDE, December: log regression of FDI intensity in terms of profits on proprietary assets and organizational and managerial skills and other determinants, using US Internal Revenue data averaged for 1967-70 for approximately the 3-digit level of industry classification.

D) P. Buckley and R. Pearce (1981), "Market Servicing by Multinational Manufacturing Firms: Exporting versus Foreign Production," MDE, December: Exams 523 business firms covering 22 countries, 19 industries, for 1977. Uses several dependent variables like Pugel's study and firm size and firm size squared as principle independent variables plus dummy variables.

E) A. Hollander (1984), "Foreign Location Decisions by US Transnational Firms: An Empirical Study," MDE, March: Regression of two dependent variables (share of given country's consumption coming from US affiliates plus from US homeland, share of foreign country's total industry output supplied by US firms as exports) on several independent variables like RND intensity, market size, trade barriers, factor endowment, taxes, and other variables.

F) J. Clegg (1987), Multinational Enterprise and World

Competition, chps 1, 2, and 4 (selected pages on results): uses Dunning's eclectic model (OLI) with foreign intensity regressed on various independent variables like technology intensity, capital intensity, skills, complexity of management).

G) J. Dunning (1988), Multinationals, Technology and

Competitiveness, chps 1, 2 (model) and 6 (technology diffusion): Hypothesizes that where international technological competition is the greatest then technological interdependence and dissemination will be greater. In other words, where host countries for a given industry have a high level of technological innovation among the firms in the industry, a linkage develops between their firms and the foreign firms in the countries who are also technological innovators. A network develops. Where technological capacity is weak in the host country, MNEs will drive such firms out of the industry, further reducing technological capacity of host country. Technological development remains concentrated in the MNE's country. Develops an inverted U-shaped curve relating RND activity of US foreign affiliates to RND activity of home firms.

H) M. Hirschey (1981) "R&D Intensity and Multinational Involvement." Using Forbes' data for 1978 and a two-equation model relating RND intensity to foreign involvement and other variables and then foreign involvement to RND intensity and other variables, finds support for risk as a determinant and diversification as a determinant. Mixed results for interdependence. Firm size is not significant. (Note: Our model in course will resemble his model.)

I) S. Graves and N. Langowitz (1996) "R&D Productivity: A Global Multi-Industry Comparison," Technological Forecasting

and Social Change, October. This important study regresses the log of patent output for 1992 against the log of 5-year average R&D and dummies for industry and country. It finds significant decreasing returns to scale in the production of patents as an index of technological output.

See, J. Dunning, Multinational Enterprises and the Global

Economy, 1993, chp 2, for a geographic distribution of the world's top firms.

Also, see Business Week, July 8, 1996 for the top 1000 global firms by country (only total sales, assets, and profits, no breakdown of firm by country).

Read also, chp 1, particularly part B, the largest MNEs, in the World Investment Report 1996.

9. MNEs and technology production and transfer.

Key microeconomic issues over how best to use p-assets.

Technological change in detail (Schumpeter, classification, knowledge production function, scale of RND lab, firm size, the effect of tech change on cost and production).

Market structure and technological change (Kamien and Schwartz and Arrow).

Technology transfer, type of ownership, and investment in training at subsidiary (host country) (see link).

Technology transfer, investment in training model, and demand for labor under uncertainty and different market structures (see link).

Empirical relationships and determinants of return from foreign investment in RND.

Licensing determinants.

Diffusion of technological change: the signod model and its determinants, product life-cyclical model.

General world equilibrium and allocation of capital.

See, Caves, chp 7, also, reading #14, Knickerbocker chp 1, and WIR99, Chapter VII.

10. Economic benefits and costs of FDI to host countries.

However defined, net benefits b = (B - C) to the host country must be analyzed in a dynamic context, as a stream of b over time, b(t). But, there are alternative streams, depending on the industrial impact of the FDI, b(t, A), where A stands for a bundle of allocations (like FDI in basic industries like steel and textile with some in consumer goods like coca cola). So, host/source countries' public policies must select an impact A*, such that the discounted present value of the corresponding stream is a maximum. No easy task. (see link).

The theoretical issue is will the world market (aided by government policies) create forces or signals for private decision makers to respond to, such that the optimum stream is realized. Related is the issue of whether foreign trade between host and source countries generates more or less net benefits than FDI. Also at issue is how the net benefits are distributed among the people of the host country and over what time profile.

See, Root, International Trade and Investment, 7th ed., 1994, chps 22 and 24.

See, WIR 1996, reading #4, chapter on policy.

See, Caves, Chp 10.

11. Final exam covers both Parts I and II, time and place to be arranged (usually the last Saturday).