Globalization: Impact on Trade and Rise of MNCs - Essay Example

? Evaluate the ment that Foreign Direct Investment is the defining activity of Multi - National Companies. Contents Introduction 3 Globalization: impact on trade and rise of MNCs 3 MNC and FDI goes together 4 Theory of FDI 5 Dunning's theory 6 Hymer Theory 7 Rationale for MNCs to use FDI 7 Examples: companies that benefit from FDI 8 Example of Apple in the use of FDI 9 Advantages and disadvantages of FDI as compared to exporting 10 Advantages 10 Disadvantages 11 Conclusion 12 References 13 Introduction The aspect of globalization has changed the nature of global transactions and international trade. These changes have developed due to the rise of foreign direct investments and increase in the number of multinational corporations. The rise in the number of multinational corporations has gone hand in hand with the increase of foreign direct investments. The multinational corporations have tapped the opportunities of tax incentives, cheap labour, technological leverage, cost benefits and made good use of the comparative advantage of the host economies to increase their production and profitability. There are major theories that explain the activities of the multinational corporations to engage in foreign direct investments. While there is a wide belief that multinational companies have engaged in FDI due to the fluctuation of interest rates, it has later been theorized that the activities of foreign direct investments by the MNCs are not only guided by profitability and exports but also focus on keeping control over their productions in the overseas market which could be evidenced by several property rights executed by the MNCs. The activities of the multinational corporations in engaging into foreign direct investments could be justified by the relative advantage of Foreign Direct Investments over exporting of goods and services. Globalization: impact on trade and rise of MNCs Globalization is the process of world-wide integration of products, services, ideas, knowledge and various forms of culture due to international exchanges across various countries all over the globe. The aspect of globalization emerged in the 1980s and spread rapidly in the 1990s leading to rise of trade and transactions across the international boundaries. The various fields in which globalization has influenced the economies all over the world are in the fields of trade and business transactions, investments in cross-border opportunities, movement of people across geographical boundaries and the transfer of knowledge from one country to another. Globalization had huge impacts on the activities of international trade (Krugman and Obstfeld, 2009, p.48). Due to the opening up of barriers of the economy, the new avenues for investments opened up for the companies that operate in the international stage. The ability of one country top produce goods and services over the other countries led to the comparative advantage of that country over its trading partner. These opportunities were explored by the corporations who had the potential to expand their business in the overseas markets and take advantage of the resources that were available at a less cost leading to comparative advantage. This led to the exchange of capital, goods and services, technologies across the international borders due to which commercial trade and transactions cropped up. The trading activities were funded by the multinational corporations who were ready to invest in more than one country and execute trading activities to attain absolute advantage over other market players. The globalization of trade was fuelled by the rise of multinational companies and trading activities flourished as it contributed to the growth of GDP of the economies all over world. Thus globalization laid the platform for the rise of multinational corporations whose activities of investments, production of goods and services led to the increase of trade all over the world. MNC and FDI goes together The multinational corporations are business entities that have presence in more than one country and carries out their business in line with the laws of the respective jurisdiction. The rise of the multinational companies has taken place mainly due to the economic policies on the foreign direct investments. The foreign direct investments are business ventures by the foreign business entities in the country that have opened its economic barriers and encouraged investments by the foreign enterprises in order to develop the economic status of their country. The rise of foreign direct investments have several benefits like shift of bargaining power from the business to the consumers, increase in competition level, high quality of products and services, high employment opportunity, rise of income level and economic demand and overall increase in the production volumes and the GDP of the country. In order to take advantage of the infrastructure provided by countries due to their global policies of economic liberalization, the multinational companies have targeted the foreign markets for investment (Piggott and Cook, 2006, p.57). This led to the increased focus of the multinational companies to invest in the foreign markets that offered then incentives in the process of production of goods and services. The foreign direct investments were the activities by the multinational companies in the era of economic globalization. Thus the volume of FDI that has grown from the periods of 1980s and the 1990s was largely due to the increasing investments by the multinational corporations in order to tap the opportunities that were specific to the foreign markets. The multinational companies and the foreign direct investments go hand in hand and the activities of the multinational companies have been defined by the growth of foreign direct investments. Theory of FDI The main theories of Foreign Direct Investments explain its characteristics and the fact that FDI could not be only considered as the process of export. The objectives of FDI are to benefit from the ownership, location advantages of foreign investments due to the globalization of trade in the world wide economies. Dunning's theory Dunning’s Theory includes five stages of Foreign Direct Investments as explained below. The first stage talks about the situation when the multinational companies engage into foreign direct investments in the overseas markets. The countries attracting the FDI experience a low inflow of FDI in this stage as the multinational companies start to realize the potential opportunities of the local markets. At this stage there is no outgoing FDI from the host economies and hence low capability for exports. The second stage of growth of Foreign Direct Investments witnesses growing trend in the foreign direct investments by the multinational companies in the hoist economy due to the advantage of cheap labour, available natural resources, etc. The multinational companies are encouraged in FDI due to the rising standard of living. As the domestic industries are still vulnerable, the outgoing FDI is very low and the capabilities for exports are not improved by much. The third stage shows that the activities of FDI would get intense due to the increasing concentration of the multinational corporations. However, the nature of FDI would change due to the increase in wages and the employment rate. The domestic industries would be in a stronger position and the outgoing FDI and the exports would start to increase. The fourth stage resembles that economy of the host country would get stronger and the outgoing FDI would start to flow freely with the objective of seeking advantages in the foreign markets. At this stage, the exports of the host economy would flourish with the development of comparative as they would be able to produce goods and services at a comparatively cheaper cost as compared to their trading partners (Rugman, 1996, p.76). The fifth stage as described by the Dunning’s Theory explains that the inflow and outflow of FDI would reach the state of equilibrium. Thus, Dunning’s theory explains that foreign direct investment is not just exports. However, the growth of foreign direct investments lead to the rise of economy and strengthening of domestic industries which provides comparative advantage due to which exports from the host economy increase in the later stages. Hymer Theory Hymer’s Theory of FDI highlighted the role of multinational corporation in the wide spread growth of foreign direct investments. Prior to Hymer, it was theorized that international investments take place as a result of the fluctuation of the interests. Hymer first proposed that the multinational corporation engage into foreign direct investments with the objective of keeping control over its production or to take advantage of the relative lower cost of labour and other available resources in the overseas markets. This theory is widely accepted in the field of FDI which could be supported by the various property rights established by the MNCs in case of transfer of capital, technology and knowledge (Ietto-Gillies, 2012, p.64). This theory supports the fact that FDI is not just exports as the engagement of MNCs in FDI is not driven only by profitability but is also influenced by the objectives of keeping control over its production, various patents, technological processes, etc. Rationale for MNCs to use FDI The reasons why the multinational companies engage into activities of foreign direct investments have been explained as follows. Due to the effects of globalization, the avenues for investments has opened up for the multinational corporations with potential opportunities for investment in various sectors of manufacturing, construction, consumer electronics, pharmaceuticals, technology in the overseas markets. The multinational corporations are drawn into foreign direct investments as a result of the favourable infrastructure, regulatory framework and business laws laid by the governments for attracting foreign direct investments (George and Bache, 2006, p.53). The availability of cheap labour, cheap resources for the purpose of production and manufacturing, the stability of the political and business environment, technological advancements in the host economy are favourable factors that attract multinational comp0anies to engage into foreign direct investments. The countries that have attained comparative advantage through the establishment of suitable infrastructure are preferred destinations for the FDI by the multinational corporations. Due to the comparative advantage, the multinational companies are able to reduce their cost of production and the prospects of profitability increases. These are possible reasons why MNCs engage into FDIs as they are able to repatriate profits earned from the overseas ventures to their home country which justifies the returns on investment (Cheng and Hitt, 2004, p.47). Examples: companies that benefit from FDI There are more than 63000 multinational companies and their affiliates that take part in the foreign direct investments in various cross-border ventures all over the world. These companies manage the business transactions and trading activities among their affiliates and then internalize these transactions and trade within their system in the foreign markets. The trading between the multinational companies also takes place in a large scale over the world which is often referred to as the intra-industry trade. The foreign direct investments and the activities of foreign trade by the multinational corporations and the intra-industry trade together accounts for two-third of the total trading activities of business all over the world. Although it is difficult to prepare a list of more than 60000 companies that benefit from the activities of foreign direct investments, some examples include the Apple, General Electric, General Motor, Toyota, IBM, Volkswagen, Honda Motors, Sony Corporation, Hewlett Packard, etc. These companies have benefitted from the engagement into foreign direct investments. Apart from using the comparative advantage of the host countries to reduce their production cost, the co-ordination of the transactions between their affiliates and internalizing the trade within their system across international borders has helped them to achieve economies of scale over a period of time. Example of Apple in the use of FDI The example of Apple Inc. as a multinational corporation of the US could be mentioned in the context of foreign direct investments that have been adopted by the companies for the worldwide spread of its business of computer hardware, software, operating systems, and consumer electronics items all over the world. Apple in the largest publicly traded MNC in the world in terms of market capitalization. In order to maintain its market shares and achieve sustainable business growth, Apple has engaged into foreign direct investments in countries like Ireland, China, etc. In line with the theories of FDI, the investments of Apple Inc. in the overseas market have been done by looking at the comparative advantage of the host economy. This has allowed Apple Inc. to attain absolute advantage over the competitors in the computer hardware, software and electronics market. The industry of computer software and hardware products in which Apple Inc. operates in largely driven by the factors of innovation. Thus the costs for research and development are extremely high which is to be borne by Apple in order to attain competitive advantage over other players in the industry. Thus the alternate option of global outsourcing has affected the decisions of foreign direct investments as Apple needed to control their organizational costs in order to keep overall control of the total cost of production. In order to get the benefits of foreign direct investments, Apple has analyzed the positions of comparative advantage of the host economy in terms of technological advantages and the cost incentives offered for their business. The foreign direct investments in Ireland, China, etc are testimony to the fact that Apple Inc. has been able to benefits from the foreign direct investments in these countries. The tax rates in Ireland in the 1990s were quite low due to which Apple engaged into foreign direct investments in Ireland to take advantage of the tax benefits and save on their cost of production in the overseas market. The FDIs by the US software MNCs in the economy of Ireland in the 1990s surpassed that in the developing countries like China, India, etc. due to the tax incentive provided by Ireland. Several MNCs like Microsoft, Apple also transacted and traded among themselves which gave rise to intra-industry trade. The benefits of technology and tax incentives received during FDIs by Apple helped them to attain economies of scale over a period of time. In China, Apple benefitted from the FDI which was not possible through export of its products or licensing its operations to Chinese affiliates. The rising middle class of Chin and the huge demand of Apple i-phone in Chinese markets led the company to take decision for FDI in China (Schneiders, 2010, p.46). Thus, Apple could expand its market share through FDI at a comparatively low cost due to the already prevailing market demand. The intra-industry trade with other multinational corporations has helped them to exchange useful resources and technologies at cheaper cost. Thus, the technological leverage, cost benefits and tax incentives received by Apple due to foreign direct investments have helped them to achieve economies of scale. Advantages and disadvantages of FDI as compared to exporting Advantages The foreign direct investments have strategic advantages over exporting that could be witnessed in the case of foreign direct investments by Apple Inc. The FDI are direct modes of entry to the overseas market whereas exporting by Apple would have been an indirect entry mode in the foreign markets of Ireland, China, etc. Through the process of internationalization by FDI in the overseas markets, Apple has been able to reduce the transportations costs which had to be incurred if it had exported its electronics and software products in the foreign markets. The trade barriers in terms due to the inefficiency of the suppliers and distributors have been reduced through ownership control of Apple over the manufacturing and distribution of its products. FDI has allowed Apple to get localization benefits due to the cheap labour, tax incentives, technological framework and cost benefits of the local market which could not be achieved in case of exporting its products. FDI has allowed Apple Inc. to attain the benefits of globalization through direct presence of its business division instead of intermediaries selling the exported goods of Apple. As compared to exporting, FDI has also allowed Apple to bring necessary modifications in the design of its products and other features like the cost, quality in line with the market demands to generate revenues in the overseas markets to the fullest potential. Disadvantages The disadvantage of FDI as compared to exporting is applicable in case of FDIs of Apple which have been explained as follows. The activities of foreign direct investments include a high organizational cost for establishment of the business. The company needs to run the entire business operations in the foreign market in parallel to that in the domestic market. Thus there is an obvious risk of return on the investments done by the multinational corporations in case of FDIs in the foreign economies. Apple has also been required to incur the country risk on the expected investment returns in case of FDIs in Ireland, China, etc. This risk is minimized in case of exporting as the risk in this case is only limited to the cost of the products that have been exported (Lee and Lee, 2007, p.26). In case of specialized sectors like the technology industries where the share of cost for innovation, research and development is quite high, the foreign direct investments for the companies may be disadvantageous as compared to the exporting of goods and services. Apple has also faced this disadvantage which was, however, justified by the huge demand of the Apple products in the foreign markets of China, etc. Conclusion The foreign direct investments have defined the activities of the multinational companies since the time of the 1980s when the governments started to adopt the policies of economic liberalization that led to globalization of industries, products and services, technologies, knowledge, etc. The scope of foreign direct investments has led to the rise in the number of multinational corporations who have focused on the opportunities of FDI to expand their business in the overseas markets. Several examples of the companies could be highlighted that has taken the path of foreign direct investments in the overseas markets to achieve sustainability in the competitive business world. The examples of Apple, IBM, Microsoft, General Electric, General Motors, etc. are evidence to the rise of FDI in this age of globalization. These multinational corporations have analyzed the advantages and disadvantages of the foreign direct investments as compared to the activities of exporting. The foreign direct investments have proved to be advantageous as it allowed the companies to establish an ownership control over the market structure where it entered into foreign direct investments. The companies have also been able to reduce their transportation costs and achieve the benefits of local labour, wage rates, control over revenue generation which could not be obtained in case of exporting. The establishment costs in case of FDI is, however, greater in case of FDI as compared to exporting which have been justified by the MNCs where they have observed potentially higher market demand and favourable business environment in the foreign markets. References Krugman, P. and Obstfeld, M. 2009. International Economics: Theory and Policy. 8th Edition. Boston: Pearson Education. Piggott, J. and Cook, M. 2006. International Business Economics: A European Perspective. Basingstoke: Palgrave. George, S. and Bache, I. 2006. Politics in the European Union. Oxford: Oxford University Press. Cheng, J. L. C. and Hitt, M. A. 2004. Managing Multinationals in a Knowledge Economy: Economics Culture. Illinois: Elsevier. Rugman, A. M. 1996. The Theory of Multinational Enterprises: The Selected Scientific Papers of Alan M. Rugman, Volume 1. Cheltenham: Edward Elgar Publishing. Ietto-Gillies, G. 2012. Transnational Corporations and International Production: Concepts, Theories and Effects. Cheltenham: Edward Elgar Publishing. Lee, H. and Lee, J. H. 2007. An empirical assessment of a tradeoff between FDI and exports. Seoul: Korea Institute for International Economic Policy. Schneiders, S. 2010. Globalization and Apple's Respond to the International Game. Norderstedt: GRIN Verlag. Read More