The Role of International Companies: NAFTA vs EU - Research Paper Example

The Role of International Companies: NAFTA vs EU Introduction International Business has always been on the basis of the comparative advantage offered by a location (Smith 1776). Prior to the Industrial Revolution of the 18th century this was in the shape of Trade conducted between nations where cost effective products of one nation moved to the other. After the Industrial Revolution mechanization enhanced production and trade moved on the basis of seeking markets. Soon with growth in rival firms engaged in same or similar business comparative advantage was overtaken by the need for competitive advantage. Firms now sought this through resource seeking trade and this factor became a major incentive for international trade. After the Second World War and with new political re-alignments international trade was developed based on four motives; market seeking, resource seeking, efficiency seeking and strategic asset seeking (Behrman 1972). Dunning (2000) identified that by the turn of the century resource seeking and market seeking motives became the drivers of foreign business as resources fell short in the home country which limit growth of firms while the required resources are readily available abroad. This encourages the firm to go international to become competitive in the home market and many firms exploited this situation. Birth of Regionalism With adoption of liberalization and free market policies by the developing world, trade barriers have either blurred or fallen through with change in national policies. But single nations do not have high negotiating power. As a result Regionalism has begun to be seen as strength for negotiating with more power. All over the world a new order has come to prevail in economic terms and that is promotion of regional economic powers through what is known as Free Trade Areas (FTA). With expansion of trade between several countries shifted from bi-lateral to multi-lateral agreements involving more countries and this was the birth of FTA. They are the new drivers of growth and development. They make use of country comparative advantages, encourage specialization and division of labor, expand the size of export markets, exploitation of abundant resources within the region and promote efficiency and competitive environment within the region. Efficiency results in competitiveness and improves performances. This in turn increases customers and creates more jobs. Inefficient firms close down or are merged into efficient firms who look for enhancing capacities. This also results in temporary loss of jobs, but jobs are quickly re-created by expanding efficient firms. The European Union The oldest FTA was the former European Economic Community (EEC) that was formed by six nations, Belgium, France, Germany, Italy, Luxembourg, and the Netherlands. The intention was to form a designated group of countries that agreed to eliminate tariffs and restrictions on most goods traded between themselves to promote greater economic benefit. When others realized the benefits of this association, they too joined and the EEC expanded and became an economic bloc that negotiated uniformly as one unit with other nations to set quotas and preferences for the benefit of EEC members. It has now expanded to become the European Union (EU) with more things in common besides free trade between its members. The EEC became a Custom Union when its members opted to have a common external policy towards non member nations. But by1990 it took another giant step by becoming a Common Market when it allowed free movement of labor and capital between its members. The next step was becoming a Monetary Union by having a common currency, the Euro. It is now attempting to become a Political Union by working towards having common laws for its member states. The result is there for all to see. Per capita incomes and GDP are rising in all member states, more jobs are being created every year and the entire Union is in a better bargaining position with other countries and regions benefitting its consumers. The relative stability that has resulted from all these moves also makes the EU a secure destination for investments. But does it make it a preferred destination over say the NAFTA? NAFTA The EEC and its Common Market became a model for formation of other FTA’s around the globe. With an FTA between US and Mexico, called NAFTA, their industries, workers and consumers all stand to gain similarly as in the EU. The major difference is that NAFTA has not become a Monetary Union but the relative strength and use of the US currency takes care of this anyway. Sharing of borders and abundant cheap labor invites US industries to set up manufacturing bases in Mexico and a NAFTA partner it offers several benefits to the US industry. In return it is offered higher employment, tax revenues and a general improvement in the GDP. In fact Mexico has almost become another state of the US as the US industry dominates the scene. NAFTA vs EU As explained above, among the four motives of International trade resource seeking and market seeking are the most common. For the US companies the resources offered by Mexico were abundant cheap labor and relatively lower cost of setting up plants to manufacture various industrial and consumer goods. However Mexico does not offer a huge or affluent market. Nor does it offer any financial resource, except for lower taxes, which were not very interesting as the major companies could save on taxes anyway due to their multinational status. In terms of availability of strategic assets too there is no special reason to come to Mexico. Besides apart from US companies it really fails to attract investments from other countries. In marked contrast EU offers a bigger market that is far more affluent. It also offers tremendous resources, financial as well as technical and administrative workforce, research and development opportunities, a high and respected education system, extensive logistic support and access to major financial and commodity markets of the world. It also offers several strategic assets and alliances as the growth of companies, technologies and institutionalized political systems offer growth opportunities. Mergers and acquisitions (M&A) are also becoming popular as they provide immediate resources of production, marketing as well as sourcing facilities which would otherwise take long time to materialize and mature. They also reduce the pains of erecting, assembling, organizing and planning of new facilities and a host of other problems like obtaining permissions and clearances from authorities. The strategic assets are sought after for value as foreign investments as they present an opportunity for investments minus the initial headaches. However there are certain risks involved when investing in NAFTA and the EU. A firm needs to asses and understand these before attempting to enter these markets. Risks - Ownership and Control The internal capabilities of a firm are based on their accumulated experience (Ferreira, 2005). This produces control competence. Managements are keen to have control as this ensures implementation of strategies. With diluted ownerships control becomes an issue and competitive advantage is likely to be lost. But firms do realize that on entering unknown territories they need local guidance that can come through Joint Ventures (JV). A JV ensures that the investing company has an equity based entry and thus EJVs have an advantage over a direct ownership. Shared equity arrangements result in better governance for protection of the knowledge-based resources (Dyer, Kale & Singh, 2004). Both forms have advantages and disadvantages and entry mode depends largely on the external environments that are usually not controlled by the entrants; hence the choice becomes difficult. Hill (2007) has elaborated on this subject in great detail. According to him a JV contributes to competitive edge in many ways; marketing knowledge of the local partner, cultural customs and the knowledge of local business practices are the most obvious ones. Indeed the sharing of equity by the local partner also ensures that they share the risks and costs of the operation. There is also a political risk in a host country and that is of nationalization on grounds of local reasons. This becomes more manageable in case of a JV. Hill (2007) goes further to list the disadvantages of the JV method as well. The foremost is that the foreign partner has to share its technology with the local partner. This can cause a loss of control besides chances of leakage of proprietary knowledge. Due to this there can be a holding back of vital inputs that can be detrimental for the JV and can either jeopardize the JV or at least reduce its competitive edge. This type of shared ownership will come to naught with mistrust on either side and does not work in the case of technology sensitive companies. There a many contradictory institutional interventions in a regional set-up despite the claims to conformity due to disparate cultural make-up of the member countries. A JV also contributes to reduction in risk caused by institutional interventions (Henisz, 2000). At the end of the day however, competitive advantages emerge from resources and capabilities developed in clusters fostered in host countries (Tallman et al 2004); and firms have to weigh various options to obviate the risk in the current trend of regionalism. Conclusions The forces of comparative advantage and competitive advantage force nations to form alliances. This trend is growing as can be seen from formation and strengthening of such alliances all over the globe. While there are both pros and cons to such attempts the fact is that political re-alignments are the major cause of such partnerships. This makes international business more fragile. Political forces are more idealistic and less practical in nature especially in countries that have just begun tasting the larger profits in a free trade economy. Even the worst case of a totalitarian regime has now converted to capitalism but with control lying in the hands of the elite of the society the danger of overnight socialism cannot be ruled out. Such a changeover will upset all plans of the well meaning firm that forays into such a sensitive area. It is in this respect of the high political risk factor that EU scores over other FTAs and certainly over NAFTA. Although NAFTA is backed by the strength of the US yet the vulnerability of Mexico can render higher risk in the area when compared to the EU as a destination for an International operation. The only real advantage that NAFTA has over EU is that it serves as the former serves the interest of the US firs as it provides them with a cheap and strategic location that is logistically in their back yard. Apart from this there is no real advantage of resources, efficiency or market seeking motive that can drive a US firm to Mexico. In all cases where proximity of the location is not vital, EU is certainly a more promising as well profitable location. Bibliography Behrman, J. N. (1972). The Role of International Companies in Latin America: Autos and Petrochemicals. Lexington, MA: Lexington Books Dunning, J. H. (2000), Regions, Globalization and the Knowledge Based Economy (eds Dunning). Oxford University Press Inc. NY Dyer, Jeff. Prashant Kale and H. Singh. (2004). When to Ally and When to Acquire? HarvardBusiness Review. July-Aug Ferreira, M. (2005). The effect of the MNC's capabilities and knowledge strategy on the degree of equity ownership acquired. Unpublished doctoral dissertation, The University of Utah, USA. Hill, Charles W.L. (2007), “Foreign Market Entry”, excerpt from: International Business – competing in global market place, Mc Graw Hill, Irwin Henisz, W. (2000). The institutional environment for multinational investment, Journal of Law, Economics and Organization, 16(2):334-364. Smith, Adams. (1776), The Wealth of Nations, Oxford Tallman, S. Jenkins, H. & Pinch. (2004). Knowledge, clusters, and competitive advantage, Academy of Management Review Read More