Econometrics Modelling of the Determinants of FDIs - Assignment Example

2. Antidumping has become an excuse for special interests to shield themselves from foreign competition i.e. imports at the expense of both consumers and other domestic companies. Discuss this statement. Antidumping can be used to protect nascent industries from unfair competition from foreign sources, but at a certain point these industries must be developed enough to be competitive on their own, otherwise the antidumping starts to have negative impacts on other industries and consumers. A good example is the antidumping regulation of machine bearings in the US; due to political lobbying pressure from a small but aggressive industry association, the importation of machine bearings is subject to heavy tariffs and quota restrictions. But the existing bearing industry is unable to produce adequate supplies at competitive costs for all the other industries that need them – auto manufacturers, and manufacturers of other kinds of equipment. Manufacturers have two choices: they can either import the more expensive foreign bearings to obtain sufficient supplies, and pass the added cost on to the consumer, or they can source bearings from purely domestic sources, which places a limit on how much of their own products they are able to produce. This reduces the supply of the manufactured products, which again drives up prices to consumers according to the basics of supply and demand. Another factor of antidumping is that it discourages product development or production efficiency, because it removes competitive pressure. The interests who benefit from antidumping protection are not forced by competition to improve their products or lower costs, so their consumers are potentially faced with two problems: lower-quality products at higher prices. Unless the product is one that has a captive market, i.e., is a necessity that a large number of consumers must buy regardless of the quality or cost (such as basic staple foods), demand for the product will decrease if low quality and high prices persist. Demand for more expensive, higher-quality imported alternatives will probably increase, but only to a point; high prices limit the amount consumers can purchase. Thus, the antidumping beneficiaries only hurt their own interests, if antidumping protection is extended beyond its useful time period – the market they were trying to protect will almost always eventually contract. 3. Differentiate between External and Internal economies of scale. Explain how these occur and the implications for the firms and industries in which they are present. External economy of scale refers to the size of a firm’s external environment – its market and the size of its industry, particularly with respect to the breadth and depth of its supply chain. Internal economy of scale refers to the breadth and depth of the firm itself, the size of its own value chain. One example of a type of firm with a large internal economy of scale would be an automotive manufacturer like Toyota. Toyota produces a large variety of vehicles in vast numbers, and controls virtually all of its value chain, from research and development (not only for whole vehicles, but also for major components for which there is a secondary market, such as engines), fabrication, assembly, distribution, and marketing, and even includes supporting value chain steps such as racing and motor sport development, which provides additional combined R&D and marketing functions. Toyota also has a large external economy of scale; both its supplier and consumer markets are global, and as a consequence Toyota’s internal scale has grown to take advantage of it. External economy of scale grows when there is an advantage to expanding (i.e., increasing the internal economy of scale) into new areas in order for the firm to more efficiently access sources or markets, or access new sources or markets, or both. Using the Toyota example again, it might be more efficient for the company to locate a factory that fabricates steel body parts near where the raw material steel is produced, or locate a vehicle assembly factory in an area where there is a large consumer market for Toyota vehicles; in both cases, the physical distance between steps in the supply chain is reduced, lowering costs and allowing Toyota to be more competitive. The external economy of scale also grows through ‘clustering’; firms supplying Toyota’s factories, and the firms supplying those suppliers, move into the local area for the sake of efficiency just as Toyota did. The implication is that expanding economies of scale are beneficial, improving efficiency and productivity, which ultimately benefits the market by providing a greater variety of better products faster and at lower costs. 4a. Briefly explain Vernon’s Product Life Cycle (PLC) theory and Dunning’s Ownership, Location and Internalisation (OLI) paradigm. The PLC Theory describes four stages of a product’s life in the context of internationalization: Introduction, Growth, Maturity, and Decline. In the first stage, a new product is developed and is manufactured for its home country, and near the end of this stage begins to be exported to other developed countries. In the second stage, increasing exports of the product make it advantageous or necessary to start production in the destination countries, which shifts capital and management and reduces exports from the home country. In the third stage, competition and a saturated market make it advantageous or necessary to shift production to developing countries with lower production costs. In the fourth stage, it becomes undesirable to continue to produce any of the product in the original home country (and sometimes the second-stage countries), as demand for it has dwindled; therefore, production is entirely shifted to the lowest-cost countries, and the product is imported back to its home country to satisfy demand. The OLI or Eclectic Paradigm describes how firms make decisions to invest in foreign countries. O stands for ownership advantages; if these largely intangible firm attributes outweigh the additional costs an international firm faces in comparison to a local competitor (such as language/cultural barriers, communications/transport costs, or legal/regulatory costs), then the investment is an advantage. L stands for location advantages, and is usually divided into political, economic, and social/cultural factors; if these are positive, the investment is an advantage. I stands for internationalization advantages; these largely relate to the comparison between exporting or producing nearer to markets, and if the latter is a positive choice, then the investment is an advantage. In general, there must be some advantage in all three (O, L, and I) for a foreign investment to be considered a good choice. 4b. How well do these two (PLC and OLI) theories explain Foreign Direct Investment (FDI)? The major drawback to PLC theory is that it is out-of-date; it assumes that companies fully-develop their products in their home countries first before expanding, when in reality, companies are much more interconnected on a global scale now. In other words, expansion based on production considerations alone may not result in a significant advantage, depending on the product or the company’s structure. If the PLC were ‘turned around’ and approached from a potential revenue rather than a potential cost-saving perspective, it might work better. OLI has the disadvantage of potentially being misleading, because it suggests some factors are separate when they may in fact be closely connected, and the I in fact may be somewhat redundant. The paradigm does allow for differences in firms where PLC does not, but otherwise serves only as a general guide to what sort of planning factors need to be assessed rather than a guide to how they should be assessed. 5a.What are the four basic strategies Multinational Enterprises (MNEs) firms might adopt to compete in international markets? Discuss the advantages and disadvantages of each strategy. The four basic strategies of MNEs are international, multi-domestic, global, and transnational. The advantage of the international strategy is that it costs the least; a home-country product is distributed in foreign markets in relatively unchanged form, tapping demand created by the strength of its brand. The disadvantage is that distribution costs increase considerably, and the available markets are often limited by the nature of the product; for example, Chrysler uses an international strategy to distribute its luxury sedans, even though many countries do not even have roads suitable for large, powerful cars. A multi-domestic strategy has advantages when there are many well-defined markets, but of relatively small sizes. One benefit is that centralized management can be reduced to a relatively small part of the country, but a disadvantage of this is increased costs in communications, and the risk of harmful inconsistency in the output from one market to another. A global strategy approaches the entire world as a single market, which has the advantages that come with internal and external economies of scale; the giant aircraft manufacturers Boeing and Airbus are good examples of companies with global strategies. The disadvantage to a global strategy is that the entire value chain is interconnected on a large scale, so problems encountered in one part of the world affect the entire company; an example of this occurred recently with Boeing, whose new 787 airliner suffered numerous setbacks due to problems with batteries designed and produced by just one supplier. A transnational strategy is a combination of the other three strategies; the brand is international, the company’s value chain is divided into several parallel ones like a multi-domestic, but each of those has a global capacity. The big advantage to this is stability; economic or production issues in different parts of the world do not automatically seriously affect other parts of the company. The big disadvantage is the potential for loss of control; Volkswagen, a transnational with extensive presence in China, has occasionally encountered problems with its patents and technology being stolen by Chinese competitors. 5b. Briefly analyse and discuss the strategies adopted by European MNEs in Chinese Auto market, and give your suggestion(s) to European MNEs in order for them to achieve a strong global competitive position? The strategies adopted by European automakers in China have primarily been transnational, but have been approached in a step-by-step fashion. The first stage in distribution orientation, wherein partnerships are formed to distribute vehicles built elsewhere. The second stage is production orientation, where a part of the production process – such as final vehicle assembly – is shifted to China. The final stage is true transnationalism, wherein joint ventures are formed with existing Chinese automakers to reproduce the European MNEs entire value chain in China. Volkswagen AG is an example of a company in this third phase, while Daimler-Benz AG is in the second and companies like Renault and BMW are still in the first, or transitioning between the first and the second. The sequential manner of engaging the Chinese market allows these companies to establish a stable market presence before extending themselves further, and the joint-venture strategy has allowed them to access the market on a large scale rather quickly. If there is one suggestion that could be made to European MNEs, or any other for that matter, it would be to carefully manage its brand identity. Volkswagen, for instance, is a desirable brand for a great many consumers in China and elsewhere because of the quality and technical sophistication associated with “German” cars. Yet a Chinese customer may own a VW that was entirely built in China, using Chinese materials, by an all-Chinese workforce – no different, in tangible terms, than any other Chinese car, and if the Chinese market ever figures that out, Volkswagen’s competitive edge may be lost. 6a. Explain the difference between Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). FDI is “direct” investment in the sense that it is investment in a physical enterprise, such as a joint venture, a greenfield (new business) investment, or an acquisition. FPI is investment in equities (stocks), commodities, or fixed-income securities such as bonds or treasury bills. FDI requires some level of engagement and control in the business; that level might be quite low, but there is risk liability for the investor proportional to the amount of his investment (and the amount of potential loss may be much greater than the original investment). FPI on the other hand is investment without the control; there is no opportunity to manage the enterprise, but by the same token, the risk is much less, limited only to the amount invested. A good way to describe the difference between FDI and FPI is FDI requires the investment of money, intellectual, technical, and physical resources, whereas FPI requires the investment of money alone. 6b. Discuss in detail the factors (variables) surrounding the econometrics modelling of the determinants of FDIs. From the OLI Paradigm, FDI is a dependent variable of a number of other variables, some independent and some dependent. We can illustrate this with a simple equation: Resources can refer to either natural resources or the availability of other supplies, such as components (for example, electrical wire, glass, steel panels, paint and chemicals, etc. used to make automobiles) needed for production. Market size refers to the size of the consumer market, and it is to some degree a dependent variable of labor costs; if labor costs (wages) are higher, consumer spending will increase. Labor costs are a dependent variable of human capital quality; better-educated and higher-skilled workers both cost and produce more. Trade openness refers to the existence of tariff and non-tariff barriers; the lower these are, the higher imports and exports are likely to be, and the more attractive the country is for FDI. Political stability is related to the other variables in the sense that wealthier countries (bigger market size, higher labor costs and quality of human capital) that trade more tend to be more stable, and present lower risks of loss for investors. Read More