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McGill University
Management Core
MGCR 382
Jeroen J.Struben

16.Convention-protocol approach to achieve effective international agreements (major challenges, underlying I. Central Models/Frameworks/Issues/Theories 1. Comparative advantage model (understand and use its key problems, potential effective Improvements) definitions, understand key assumptions, solve numerical and graphical; contrast with absolute advantage, etc…) II. Other key concepts, issues, etc… 2. Porter’s Theory of National Competitive Advantage (and its 1. Rodrik article: key arguments and their flaws in the pro and weaknesses) con globalization debate 3. Primary elements of societal culture 2. Contemporary drivers of globalization 4. Hofstede Model (and its weaknesses) 3. Understand the existence and contemporary patterns of 5. Analyzing versus managing country risk international trade 6. (Sources for) international competitive advantage 4. Summarize and discuss the differences among the classical 7. The four basic international strategies and their relation to country-based theories of international trade, as well as their international competitive advantage sources; provide example limitations. industries and firms 5. Discuss the problems of mercantilism 8. The make-buy decision 6. Explain the importance of specialization 9. Main international investment theories (Describe and 7. Predict country specialization using the comparative categorize) advantage model 10.Motivations for collaboration (collaboration versus vertical 8. Understand the purpose of and main idea behind the gravity integration versus export) model 11.Strategic alliances: identify the benefits and limitations and 9. Heckschler-Ohlin model (how it alters the theory of risks; Identify types, scope, and compare joint ventures and comparative advantage) other forms of strategic alliances; discuss the forms of 10.Leontief Paradox management used for strategic alliances. 11.Firm based theories (describe and categorize, summarize what 12.The global commons problem: underlying principles and patterns they seek to explain, main factors of importance, necessary conditions, examples, and potential solutions; problematic assumptions) describe its dynamics; the role of property rights systems; 12.Explain the patterns of intra-product trade, Grubel-Lloyd index, what makes governing of international commons different? variation across product type etc.. 13.Interaction between non-triad firms/regions and triad 13.Explain increasing returns, the various forms and its firms/regions and its role in globalization importance for explaining competitive advantage and industry 14.Flying geese model (compare to other firm-based strategies in emergence Lecture 3; discuss shortcomings) 14.Social structure 15.Measuring (In)Equality: the Gini Coefficient 15.Social stratification and implications for international business 16.Describe the acculturation process and explain key 30.GHG emissions and climate change: why a global commons considerations of expatriate management problem? 17.Explain how religious and other values affect the domestic 31.What are major negotiation obstacles? environments in which firms operate 32.How does the interest and influence of various non- 18.Describe, categorize, and contrast various political and legal participating stakeholders come into play during the systems (and understand how this affects internationally negotiation process? Firms, NGO’s, citizens, future citizens, operating firms) small islands, animal/plant species, science… 19.Analyze vertical integration and supply chain network 33.Understand some of the major global challenges that require decisions facing international production managers intensive coordination across countries for their resolution 20.Understand the role of trade-offs and of quality in and that involve firms as central actors. competencies; explain how competencies relate to (international) value chain operation 21.Distinguish between major forms of international operation and collaboration (exporting, franchising etc..) and describe the advantages disadvantages of each 22.Major determinants of ethical behaviour 23.Understand the idea of adaptive governance principles in the global commons 24.Understand key measurements of GNP, GNI, PPP, nominal, per capita etc.. 25.Explore the development challenges facing Emerging Countries in various regions (African, Middle Eastern, Eastern and Central Europe, and South American countries) 26.Sources of Innovation: CSA’s and FSA’s for Emerging Markets 27.Examine China as a major marketplace and business center in the world economy. In particular (Attractiveness to MNE Investment; Synergies between Foreign MNE’s, and Chinese firms; Outward FDI; Government role) 28.Late Industrialization Perspective on South East Asian Countries 29.Understand implications of China’s and India’s massive scale and growing role in the global market place (positive and negative) The globalization debate - Globalization can bring about economic growth and prosperity - Globalization can weaken the power of nation governments to regulate their economies and societies - Shifting manufacturing to low-wage countries drives the cost of unskilled labor down and also decreases global purchasing power The actors (individuals, communities, firms, regions, countries, formal institutions, NGOs), and realms (economics, firms, countries, resources…) - Individuals live in global environments, purchase goods from all over the world and communicate and work without being restrained by physical distance - Companies move not only because of access to resources but also to labor, government regulations, political situations and more - Countries try to provide social and economic stability for their citizens while also encouraging economic investment by corporations I- Why study international business? - Institutions and NGOs have differing objectives, but understand that even local situations have international EMPIRICAL CONTEXT influences Major globalization patterns - Increased trade comes with increased social guarantees MAIN GOALS provided by the government Understand why international business is important - The improved mobility of capital has changed the dynamics - The external environment has become increasingly of the workforce important to companies - Governments’ ability to regulate their domestic societies is o “Strategy: the link between “who you are” and decreased with companies’ increased mobility of “where you plan to compete”” operations o Firms and industry are increasingly affected by o Fear of losing out to cheaper labor causes international situations, but they also influence their governments to decrease regulation in order to external environments remain “internationally competitive”  Ex. Civil conflict drives up the price of oil o Employers provide less worker benefits because it is - Policy changes such as privatization of public companies now easier to move their operations to a location increases the opportunity for foreign investment with a less demanding workforce o New markets and opportunities are available - Governments’ ability to regulate their domestic societies is - Changes in technology allows for better transfer of decreased with companies’ increased mobility of information, people, goods and resources between operations countries o Labor and environmental restrictions in one country o Better transportation may not exist in another country, and companies go o Better communication where it is easiest to operate o The loss of tax revenue from corporations further Examine major patterns related to international business reduces the regulatory power of governments - One thing we observe is that increased trade comes with because they want to remain attractive places for increased social guarantees provided by the government corporate investment o “a key component of the implicit postwar social bargain in the advanced industrial countries has Explain why addressing global challenges requires a broad been the provision of social insurance and safety boundary, multiple points of view nets at home… in exchange for the adoption of freer - The blind men and the elephant: a group of blind men trade policies” wanted to know what an elephant was like, so they each o Graph show that social spending has increased feel a body part. When they compare their observations, all alongside freer trade (see chart on pg. 9 of the of them are in disagreement. Each assumes the other is coursepack) wrong, not realizing that although they are all correct, not o By opening up their markets, governments expose one of the understands the elephant in its entirety their citizens to the perils of internationalization - It is important to understand that there are multiple (for example, the shifting labor market) perspectives to every situation. In order to fully understand - The improved mobility of capital has changed the dynamics a subject, we must gather opposing viewpoints and of the workforce consider every opinion as one part of the whole truth o Labor is moved to low-wage countries to secure higher profit margins MAIN LEARNING POINTS Identify and describe the basic forms of international business activities - International business is the “movement and influence of o Provide stability for and promote well-being of their people across boundaries” citizens - International trade  Develop trades strategies that maximize their o Movements of goods competitive advantage and increase o Transaction of services economic well-being - Foreign Investment o Foreign Direct Investment (FDI): acquisition of Explain major recent developments in international business foreign assets for the purpose of controlling them - International economic integration is happening as  Purchasing existing assets in a company governments and companies both reduce their role in  New investment in property, plant and providing social welfare to people equipment o Governments have less reliable tax income because  Participation in a joint venture with a local of increased mobility of companies partner o Companies are less pressured to provide employee o Foreign Portfolio Investment (FPI) benefits because of their mobility as well  Passive holdings of foreign securities such as - “open trade can conflict with long-standing social contracts stocks or bonds that protect certain activities from the relentlessness of the  No active management or control of the free market” company who issues the securities o Examples: child labor in Honduras replacing o Franchising, licensing, contracting, etc. workers in South Carolina, or pension cuts in France due to the Treaty on European Union Identify actors in international business and their roles o Globalization can undermine social norms in a way - Individuals that national governments can’t defend against o Realize the effect of their actions on the global situation Comprehend the growing role of emerging markets in the global  E.g. increased energy consumption, increased economy CO 2missions, etc. - Globalization redistributes wealth - Corporations o From the 1960s until now, developing countries o Form a strategy for international operations based have moved away from exporting agricultural on analysis of economic and global patterns products to exporting manufactured goods  E.g. impact of cultural differences, changing o The shifting of manufacturing processes to low- international trade, economic growth rates of wage countries has removed the subsistence different countries, etc. farming economies of old - Governments o Developing countries have increased wealth - BRIC countries  E.g. Wal-Mart has created an excellent value o Brazil, Russia, India, and China are seen as the chain that puts them in a position to be a cost world’s current emerging economies. They have leader large labor forces and larger populations, and they - Environments are increasingly playing a larger role in the o Decline in barriers to the free flow of products and international economy capital  Markets have been liberalized and privatized Understand that addressing global/international problems  Increased FDI and regional associations (e.g. requires tolerance for, and working with, multiple and diverse NAFTA) models and perspectives (“the blind man and the elephant”) o Development in technologies - See the story above: none of the men listened to the others’  Communication opinions and therefore none of them knew the whole truth  Information about the elephant. If we want to address global issues, we  Transportation must accept that different perspectives are as true as our own perspectives. By acknowledging alternate opinions, we Key arguments and their flaws in the pro and con globalization build a better model of the world situation and are debate (Rodrick article) therefore better able to address its issues - Globalization decreases global purchasing power o By transferring manufacturing from developed countries, where annual salary is $50000, to developing countries, where annual salary is $500, KEY CONCEPTS you remove the $45000 of purchasing power the Contemporary drivers of globalization developed worker would have used to purchase the - Strategy manufactured goods o Companies want to seek out new markets in order to o In reality, the purchasing power doesn’t disappear, it increase profitability and remain competitive is transferred from foreign factory workers to o Better communication and transportation means company shareholders and foreign factory owners access to more resources and supplies - Globalization can weaken the power of nation governments o Companies want to leverage their “core to regulate their economies and societies competencies”, i.e. what they do better than o On one hand: one of the freest trade partnerships is everyone else, in order to increase their between Canada and the US, however, Canadian competitiveness intranational trade is 20 times larger than Canada- US international trade. Therefore, even in this exemplary partnership, Canadian and US markets are separate entities. o On the other hand: in the US, for example, labor laws prevent corporations from taking advantage of workers. By outsourcing jobs to countries with fewer restrictions, corporations weaken the bargaining power of American workers and disadvantage them in a way that the US government can’t protect them from - Globalization reduces wages o Moving factories to countries with high amounts of unskilled labor does put downward pressure on wages in developed countries o In the US, most of the gap between skilled and unskilled wages has to do with deunionization and technological developments o There is a strong correlation between the productivity of workers in a country and the wage level. Therefore, the fact that workers in developing nations earn less money is mostly due to the decreased value of the labor they are capable of providing Main Learning Points Mercantilism Absolute Comparative Advantage Advantage Main Aspects -increase -increase -increase of Model: countries countries countries “treasure” overall wealth overall wealth -increase - free trade - trade is exports and when each always possible limited/no country has an between imports (aka no absolute countries based free trade) advantage in a on which is good (no trade comparative is one country better at has all the producing a advantage) good Key Concepts to be Understood 2 – Organizing Theories I: Country Based Trade Theories Trade Model Related Definitions: Term Definition Empirical Context Trade voluntary exchange of goods, services assets or International Trade: trade (voluntary exchange of goods money between one or more persons or between one or more organizations) between residences of two organizations countries International trade between residences of two countries - world trade has grown dramatically since the end of WWII Trade - international trade has important direct and indirect effects Mercantilism is a 16 century economic policy that maintains of economies that a countries wealth is measured by its - countries locations and access to resources can affect their holdings of gold and silver (treasure) international trading Opportunity the opportunity cost of a good is the value of what - Cost is given up to get that good Main Goals Understand how different models help us explain drivers of Classical Trade Theories: international trade. - classical trade theories are more related to describing trade - drivers of international trade include specialization and a need to increase countries overall wealth in terms of commodities (standardized, undifferentiated goods) - Two classical trade theories are: mercantilism and absolute they are most product at and import goods other advantage counties are more productive in) - Mercantilism: is a 16 century economic policy that maintains that a countries wealth is measured by its Specialization: holdings of gold and silver - specialization is one of the benefits of free trade o Country’s goal was to promote exports and - specialization suggest countries should export those goods discourage imports and services for which it is more productive at producing o This was ideal theory for the time as it increase and import goods and services that other countries can countries holdings and allowed monarchs to hire produce more efficiently (Theory or absolute advantage) armies to expand their realms - specialization allows for an increase of wealth of country as o People in favor of mercantilism: export oriented a whole manufactures, domestic manufactures threatened by foreign imports Comparative Advantage: o People harmed by mercantilism: - one flaw in the theory of absolute advantage is it  tax payers: they are the only who are paying incorrectly states that is one country has absolute for the government subsidies on exports and advantage in both goods, not trade will occur they have to pay higher prices for goods due - David Ricardo developed the theory of comparative to higher taxes on imports advantage to explain what happens in this situation o the burden of mercantilism was often forced on to - The theory of comparative advantage states a country the colonies should produce and export the good are services for which  the British would not allows colonial firms to it is relatively more productive exports goods that compete with British - This theory incorporates the concept of opportunity cost factories and they droved them to export in determining which goods a country should produce certain goods only to Britain to ensure a o opportunity cost of a good is the value of what is stream of cheap imports for British given up to get that good consumers o modern mercantilism supporters are called Heckschler-Ohlin Model: neomercantilist or protectionist – nearly every - Eli Heckscher and Betil Ohlin developed the theory of country has adopted one of these policies to protect relative factor endowments, now often called the a key industry Heckschler-Ohlin Model - Absolute Advantage: - The model follows two basic observations: o Adam Smith stated that the basic problem with 1. factor endowments (types of resources) vary among mercantilism was that is confuses the acquisition of countries wealth with treasure 2. goods differ according to the types of factors that are o Smith advocates free trade among countries where used to produce them counties specialize in the producing and exporting - the theory states that a country will have a comparative some goods and import others based on the theory advantage in producing products that intensively use of absolute advantage (countries produce what resources it has in abundance Leontief Paradox: Comparative Advantage - the Heckschler-Ohlin model was tested after world war two Output per Hour of Labor by Wassily Leontief France Japan - he predicted that since the US was capital abundant and Wine 4 1 labor scarce, they would export capital intensive goods Clock radios 6 5 (such as chemicals and steel) and import more labor - in this world France has the absolute advantage for both intensive goods - however where not consistent with predictions and goods - comparative advantage looks at the opportunity cost – showed US imports where more capital-intensive than US France is 4 times better than Japan an producing wine but exports only 1.2 times better at producing radios - thus was born the Leontief Paradox - Japan is comparatively better at producing radios than - many scholars argue the cause of the paradox was due to measurement issues France so both will be better off if trade will occur o Leontief only included two factors of production: Main Question labour and capital Achieving competitive advantage in an international setting is far o He did not include land, human capital and more complex than achieving it in a national setting. Some technology industries benefit more from globalization than do others and o His failure to include these may have lead to the paradox when predicting international trade some nations have a competitive advantage over other nations in certain industries. In order to achieve a competitive advantage, the firms must perform value-creating activities in a way that creates Models to Master more overall value than do competitors. This is done through lower costs or superior benefits to the consumer. Any firm that Absolute Advantage wishes to compete in an international framework has to maintain Output per Hour of Labor its competitive advantage, which can be achieved through France Japan efficiency, economies of scale, learning and reputation. Firms also Wine 2 1 have to learn how to deal with the pressures of global integration Clock radios 3 5 versus local responsiveness. - in this world one hour of labor produces 5 radios in Japan but only 3 in France Key concepts to be understood - if both are able to trade they will be better off – where France specializes in wine and Japan specializes in radios International competitive advantage: - Japan will save 1.2 hours of labor and France will save 0.33 When a firm has sustained profits that exceed the average profits hours of labor in its specific industry, then it has competitive advantage over its - Theory of absolute advantage states only works since rivals. France has an absolute advantage in wine, while Japan has When a firm produces a product at a lower cost than its advantage in clock radio competitors, then it has a cost advantage. When it produces a better product and charges a higher price, it is said to have a 2- coordination (the way that managers connect the activities of differentiation advantage. the value chain) is influenced by national cultures, learning effects, A firm obtains competitive advantage through: Global efficiencies operational obstacles and subsidiary networks. (economies of scale, scope and comparative advantage of location); Multinational flexibility (responsiveness to customers Competencies, core competencies and the process of and key stakeholders and adapting to local conditions); competency building: Worldwide learning and knowledge leverage (use people, ideas A company's core competency is essential to its competitiveness and core competencies globally and create knowledge via and profitability arises from the knowledge or skills that give it an international scope) advantage over its competitors. Companies build up their competency by focusing on product Value creation: development, employee productivity, manufacturing expertise, Value is what remains after costs have been deducted from the marketing imagination or executive leadership. revenues of a firm. Firms create value - either by making products for a lower cost than competitors make them (cost leadership): requires high production volumes, The make-buy decision: low costs and low prices. - or by making products for which consumers willingly pay a The make-or-buy decision means making a choice between premium price (differentiation): requires a unique, differentiated producing an item internally or buying it externally. The buy side and innovative product that customers value and rivals find hard, of the decision also is referred to as outsourcing. An enterprise if not impossible, to match. may decide to purchase the product rather than producing it, if is cheaper to buy than make or if it does not have sufficient The firm as value chain: production capacity to produce it in-house. Realistically, firms have to choose between cost leadership or differentiation because it would be impractical to pursue both strategies. To analyze the activities though which a firm can create a competitive advantage, it is useful to model the firm as a chain of value creating activities. A value chain is the set of linked value-creating activities the company performs to design, produce, market, distribute and support a product. These activities are either primary activities (core business functions of the firm, creating and delivering the product) or support activities (aiding the people involved int primary activities and carrying out the day-to-day execution of primary activities ex: human resources, firm infrastructure...). Managing the value chain: 1- configuration (the way in which managers arrange the activities of the value chain) is influenced by cluster effects, logistics, digitalization, business environments and economies of scale In other words, comparative advantage comes from what you do best compared to others. To know what you do best, look at the opportunity cost. N.B. Country-based theories like these help explain trade in undifferentiated goods such as wheat, sugar, and steel How can we explain why firms choose to produce in different countries? Intra-industry trade (from slides): o Allows firms to produce for a larger market o Increases consumer choice o Increases the number of domestic firms & output o Is less threatening to domestic jobs than comparative advantage based trade What are policy implications for governments? First-mover advantages implications for governments (from slides) 3) Organizing Theories 2 : Firm-Based Trade Theories and o Companies generate imports and exports National Advantage o Thus can influence government decisions on trade policy o Government can, while not create, catalyze Main Question industry formation Where does a country’s comparative advantage come from? o Strategic trade policy o Support first movers o Countries have a relative abundance of factors of  Invest to be first, particularly in global production. o Production processes use factors of production with industries or in markets which can relative intensity. support a few firms o Lesson of the theory of comparative advantage (p. 31) o Location development (National Innovation Systems) “You are better off specializing in what you do  If countries have comparative relatively best. Produce (and export) those goods and services you are relatively best able to produce, advantages Multinational enterprises and buy other goods and services from people who (MNEs) want to locate appropriate activities there are relatively better at producing them than you  Foreign Investment Decisions can help are.“ trigger externalities o Manage consequences of dynamic productivity and investment in “advanced“ factors (such as communications o E.g. labor displacement as consequence of infrastructure, sophisticated skills, and research facilities) ever-changing factories (from home location, to nearby, to next-tier country, to… (See p.544 for a table contrasting the government policy and Main Learning Points national competitiveness as explained by Porter or conventional Use the modern, firm based theories of international trade to wisdom) explain global strategies adopted by businesses (PLC, NCA, GSR/NTT) Empirical Context PLC - Product Life Cycle theory NCA – National Competitive Advantage (Porter) Inter-industry and intra-industry comparisons; GSR – Global Strategic Rivalry o Inter-industry trade is the exchange of goods NTT – New Trade Theory produced by one industry in country A for goods produced by a different industry in country B (See Key Concepts to be understood for definition of each theory) o Intra-industry trade is the trade between two countries of goods produced by the same industry Critique Porter’s theory of National Competitive Advantage How becomes an Italian footwear Industries internationally (Might be a good idea to look at the theory first  see end of successful; the growth of the new-world wine industry document, Key theory to master) ((Not so sure of what is expected here…)) Good o Porter uses the concepts and theories drawn from strategic Main Goals management to extend and reformulate the theories of Understand the role of firms in explaining sustained international trade, direct investment, and economic development competitive advantage of countries/regions o Theory encompasses both trade and direct investment o A competitive advantage does not only come from the general o Distinguishes between “basic factors“ (such as natural environment of the firm resources, climate, location and demographics) and “advanced o The resources, capabilities and core competencies are what factors“ (such as communications infrastructure, sophisticated can lead to a sustained competitive advantage. skills, and research facilities) o Emphasize the interdependence of the 4 elements, the dynamic o “Recognition that differentiation advantage through quality, aspects of competitive advantage technological sophistication, design, and product features is at least as important a determinant of trade and overseas o The strength of the theory is its cogency in explaining the investment, particularly between the industrialized nations” international success of particular industries, the nature and pattern of competitive advantage in the services industry, and o Sustained competitive advantage depends upon firms the patterns of national competitive advantage among 8 of the upgrading their competitive advantages through innovation 10 countries included within the study Bad o Useful for: Trade in differentiated goods for which o The ambitious theoretical and empirical sweep of the analysis brand names and product reputations play an has been achieved at the expense of precision and determinacy important role in consumer decision making o Lack of precision is apparent in the wholly definitions of some of the key concepts and in the specification of relationship Product Life Cycle Theory (1960s) between them. o Consist of 3 stages (more details on page 40, second o Lack of precision also apparent in the “national diamond paragraph) frame-work“: the categories overlap . 1. New product stage o Links between upgrading of competitive advantages and A lot of uncertainty national economic development are tenuous A firm develops and introduces an o Failure to perfectly reconcile micro-level analysis of innovative product in response to a competitive advantage of firms and industries with macro- perceived need in the domestic market. level analysis of national development and prosperity Most output initially sold in the domestic o Porter attempts to treat export and outward direct investment market, and export sale are limited a part of the same phenomenon and ignore their complex 2. Maturing product stage inter-relationship Value is recognized Demand for the product expands o The key weakness of the theory is in its predictive power. dramatically as consumers recognize its Ambiguity over the signs of relationships, the complexity of value. Domestic and foreign competitors interactions, and dual causation renders the model unproductive begin to emerge. in generating clear predictions. 3. Standardized product stage Becomes a commodity: focus on low cost The market for the product stabilizes. Key Concepts to be understood Firms are pressured to lower their Firm based theories (describe and categorize, summarize manufacturing costs as much as possible by shifting production to facilities in what patterns they seek to explain, main factors of countries with low labor cost. Result: importance, problematic assumptions) product begins to be imported. Linder’s Country Similarity Theory (1961): o Useful to: o trace the role of innovation, market o Hypothesized that international trade of manufactured expansion, comparative advantage, and goods comes from similarities of preferences among consumers in countries that are at the same stage of strategic responses of global rivals in economic development (similar per capita incomes) international o Problems: o Intra-industry trade in manufactured goods should be o Ethnocentric view common o Ignores globalization and integration of world economy Global Strategic Rivalry Theory (1980s) o According to this theory, firms struggle to develop some sustainable competitive advantage. It focuses on X=ixports in a certain class of products i strategic decisions that firms adopt as they compete M=Iiports in the same class of products i internationally. o Like Linder’s theory, it predicts that intra- N.B.: the broader the definition of an industry the greater is the industry trade will be commonplace too. measured level of intra-industry trade o Can obtain a sustainable advantage by: o Owning intellectual property rights Trade volume varies across product classes o Investing in research and development o Low volume if: o Achieving economies of scale or scope o Simple, undifferentiated products o Exploiting the experience curve o Products for which countries have clear comparative advantage or disadvantage New Trade Theory (1980s) – Covered in slides o High volume if: o Increasing returns of specialization due to economies of o Complex differentiated products scale o Simple products, for which countries do not o Internal economies of scale (unit costs of seem to have clear advantage or prod. decrease) disadvantage (low returns-to-scale) o External (network effects) o First mover advantages o Economies of scale such that barrier to entry Increasing returns and its importance for explaining crated for second or third company o Luck... first mover may be simply lucky competitive advantage and industry emergence o o “Returns to scale (see NTT theory) refer to changes in output resulting from a proportional change in all The firm-based theories help explain intra-industry trade and trade in heterogeneous, differentiated goods, many of which are sold on inputs (where all inputs increase by a constant factor). the basis of their brand names and reputations. If output increases by that same proportional change then there are constant returns to scale (CRS). If output increases by less than that proportional change, there Porter’s theory is a hybrid: it blends the traditional country-based theories that emphasize factor endowments with the firm-based are decreasing returns to scale (DRS). If output theories that focus on the actions of the individual firms increases by more than that proportional change, there are increasing returns to scale (IRS)“ (From Intra-product trade, Grubel-Lloyd index, variation across Wikipedia) product type N.B: Returns to scale are not equivalent to economies The Grubel-Lloyd index is used as a measure of intra-industry of scale trade: o Increasing returns allows you to be more efficient (increase output with minimal increase of input), which (X i M -i) - M i i æ X i M i ö allows you to gain a competitive advantage over your GL i *100 =100 1-ç ÷ Xi+ M i è X i M i ø competitors that might not have increasing returns, or o Related and supporting industries might not have as big increasing returns The emergence of an industry often stimulates the development of local suppliers. Key theory to Master Tendency for the successful industries within each country to be grouped into “clusters“ of related and supporting Porter’s theory of National Competitive Advantage o Success in international trade comes from the industries Competition among input suppliers leads to lower prices, interaction of four country- and firm-specific elements higher-quality products, and technological innovations in the input market, in turn reinforcing the industry’s competitive advantage in world markets o Firm strategy, structure, and rivalry Firm Strategy Structure The domestic environment in which firms compete shapes Rivalry their ability to compete in international markets. When facing vigorous domestic competition, firms develop the skills needed to succeed internationally Many of the investments made in domestic market are Factor Demand transferable to international market at low cost Conditions Conditions National policies also affect firm’s international strategies. Related & Supporting Industries o Factor conditions A country’s endowment of factors of production affects its ability to compete internationally. Porter goes beyond the basic factors of the Hecksher-Ohlin theory. He includes factors such as:  education level of the workforce quality of the country’s infrastructure role of creation through training, research and innovation… o Demand conditions The existence of a large, sophisticated domestic consumer base often stimulates the development and distribution of innovative products as firms struggle for dominance in their domestic market.  Enrich populations education  Access to new technologies  Bring in new ideas  Negative  Homogenization of culture  Affect culture through soft power o Environmental  Positive  Technology and expertise transfer from countries with high standards  Directly improve standards  Negative  Exploit natural resources  Increased waste and pollution and problematic disposals because MNCs can leave a location whenever desired o Political  Positive  Promote goodwill between home and host country  Influence can positively affect democracy and other practices in a country  Negative Lecture 5: Formal Institutions  Power asymmetry o MNCs can threaten to leave a country to o Main Questions accomplish their political goals o How do the formal institutional systems in o Can control pace and pattern of resource countries/regions affect the ability of firms to conduct extraction international business? o Economic o How do those institutional systems vary across countries?  Positive o How do firms MNCs/MNEs affect countries? (Multinational  Job creation Corporations/Entities)  Economic growth through value addition by NMCs o The impact of MNCs on countries  Upward pressure for wages o If corporations were included in rankings of top 100  Negative economies, GM would rank at 23, above Denmark. o In-class examples of impact  Loss of local/regional/national enterprises and o Cultural workforce  Potential wealth gap widening  Positive o Example: The keystone pipeline o Sources of Country Risk  Labour dispute o Political  Project or firm specific regulation  Government  Nationalization  Political parties  Corruption  Legislative bodies  Negotiation risks  Lobbying groups  NGO campaigns / Community protests  Trade unions o Perceptions of political risk  Others political institutions o In developing countries o Legal - laws that aim to”  Civil disorder  Ensure order in commercial activities  Expropriation  Resolve contract disputes  War  Protect intellectual property  Remittance restrictions  Tax economic output  Labour disputes o Political risk o In industrialized countries o Expropriation / confiscation / profit or capital repatriation  Price controls restrictions  Labour disputes o Mandatory labor benefits legislation / NGO advocacy  Remittance restrictions campaigns  Fiscal changes o Civil war / kidnapping / terrorist threats  Civil disorder o Inflation / currency devaluation / increased taxation o Corruption o Macro-political risk o Annual global bribes: approx. 1 trillion dollars o General environment o 3-5% of world economy  International financial system collapse o More corrupt countries are less likely to attract investment  World war o Entering a new market - factors to consider o Country specific o Risk evaluation vs. Risk management  Civil war or insurgency / Kidnappings o Bargaining power of host country  Expropriation o Protection through legal contracts  Rule of law o Allying with qualified local partners  Protection of private property rights o Legal systems  Environmental regulation o Civil  Fiscal policy / Price controls / Inflation  Judges must follow the written collection of laws o Micro-political Risk  Most common worldwide o Industry Specific o Common  Sectoral prohibitions on foreign ownership  Places emphasis on precedent and judicial decisions  Local content rules  Canada and USA  Remittance rules o Religious o Firm or project specific o Bureaucratic (socialist)  Extra-territoriality o There is ongoing debate on civil vs common law in terms of  Intellectual property rights which is most business-friendly.  Patents, copyrights, trademarks, brand names o Legal considerations for NMCs  Weak protection leads to high costs o Must obey the laws of the home country and all host  International treaties exist to promote protection countries o Financial systems o Much more complicated than the legal situation of domestic  Tax regulation - countries vary greatly in taxation levels firms. and enforcement o Laws affecting international business transactions o Dispute resolution o Maritime law - a legal system of its own o Which laws apply? o Sanctions - restraints on commerce with another country o In which country should the issue be resolved? o Embargo - sanctions against all commerce with a country o What technique should be used? - litigation, arbitration, o Extraterritoriality - regulation of business activities outside mediation, negotiation the home country. o How will settlement be enforced? o Laws directed at firms o Bretton Woods Institutions o Foreign firms o Exist to promote long-term economic development and  Nationalization - transfer from private sector to public poverty reduction sector  IMF - international money fund  Expropriation - gov’t takeover with compensation  Policy advice, technical assistance, loans to countries  Confiscation - gov’t takeover without compensation  Expertise: eonomists o Public Firms  World Bank  Privatization - transfer from public to private sector  Technical and financial support to help countries  Can be via vouchers, auctions, private sale, private reform particular sectors or implement certain gift projects  Key aspect is often post-transfer entry barriers  Expertise: diverse specialists o Other forces o Social Embeddedness and its importance o Accounting systems o Materialist perspective - rational choice  I.e. Sarbanes-Oxley Act (2002) - US accounting law  Influences: legal system, cultural values, international  Organizations are wealth maximizers  Formal institutions exist to give substantive incentives political ties, economic system, sources of capital and penalties o Technological systems o Cultural perspective - social embeddedness  Internal investment  Organizations should follow cultural rules  knowledge and skill level of citizens  Formal institutions are a system of moral principles,  Physical infrastructure scripted roles, and symbols.  Resources  Healthcare  Issue: aging/obsolescence  External: technology transfer from one country to another o economies of scale This theory does not explain why a firm would choose to enter a foreign market via FDI rather than exploit its ownership advantages internationally through other means, such as exporting its products, franchising a brand name, or licensing technology to foreign firms. Internalization theory addresses this question. Internalization theory relies heavily on the concept of transaction costs. Internalization theory suggests that FDI is more likely to occur--- that is, international production will be internalized within a firm--- when the costs of negotiating, monitoring, and enforcing contracts with a second firm are high Dunning’s Eclectic Theory combines ownership advantage, location advantage, and internationalization advantage to form a unified theory of FDI. This theory recognizes that FDI reflects both international business activity and business activity internal to the firm. According to Dunning, FDI will occur when three conditions are satisfied: -Ownership advantage: The firm must own some unique competitive advantage that overcomes the disadvantages of competing with foreign firms on Lecture 7: International Firms: Entry Modes and International their home turfs Strategic Alliances -Location advantage Explain the reasons for foreign direct investment (FDI) Undertaking the business activity must be more profitable in a Sometimes exporting may not be feasible therefore it forces the foreign location than undertaking it in a domestic location companies to have their products or services produced abroad. -Internalization advantage The firm must benefit more from controlling the foreign business FDI may take many forms, including purchase of existing assets in activity than from hiring an independent local company to provide a foreign country, new investment property, plant, equipment, and the service participation in a joint venture with a local partner. For direct investment to take place, control must accompany the investment. (Otherwise it is a portfolio investment.) One explanation for FDI focuses on the role of the firm. The Summarize how supply, demand and political factors ownership advantage theory suggests that a firm owning a influence FDI valuable asset that creates a competitive advantage domestically can use that advantage to penetrate foreign markets through FDI. Supply Factors Demand Factors Political Factors The asset could be: -Production costs -Customer access -Avoidance of trade o a superior technology -Logistics -Marketing barriers o a well-known brand name -Resource advantages -Economic availability -Exploitation of development locate a new facility of its own nearby, thus enabling it to -Access to competitive incentives continue to supply its customers promptly and attentively technology advantages Establishing a new facility reduces the possibility that a -Customer mobility competitor in the host country will step in and steal the customer. Supply Factors o Production costs: Firms often undertake FDI to lower Political Factors production costs. Foreign locations may be more attractive o Avoidance of trade barriers: As an example, Microsoft is than domestic sites because of lower land prices, tax rates, locating a software development center in Richmond, British Colombia, in part to avoid limitations placed by the commercial real estate rents, or because of better U.S. government. availability and lower cost of skilled or unskilled labor. o Logistics: If transportation costs are significant, a firm may o Economic development incentives: Government incentives choose to produce in the foreign market rather than export that can be an important catalyst for FDI include reduced from domestic factories. utility rates, employee training programs, infrastructure o Availability of natural resources: Firms may utilize FDI to additions (new roads and railroad spurs), and tax reductions or tax holidays. access natural resources that are critical to their operations. Identify the basic issues in international licensing and o Access to key technology: Another motive for FDI is to gain franchising, and discuss the advantages and disadvantages of access to technology. each. Demand Factors Licensing Firms also may engage in FDI to expand the market for their Under licensing agreement, a company (the licensor) grants products intangible property rights to another company (the licensee) to use in a specified geographic area for a specified period. In o Customer access: Many types of international business exchange, the licensee ordinarily pays a royalty to the licensor. The require firms to have a physical presence in the market o Marketing advantages: FDI may generate several types of rights may be for an exclusive license (the licensor can give rights marketing advantages. The physical presence of fa
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