Lecture 7→ Chapter 5: i-trade & investment 4 theories (country ...

Lecture 7  Chapter 5: i-trade & investment PORTER’S THEORY’S BEAUTY (VERY IMPT) 1. Synthesizes features of BOTH country-level & firm-level theories 2. Includes role that countries play in creating environment that may/not help firms Objective 3: Modern firm-based theories of i-trade to describe global strategies adopted by biz Firm-based theories (firm is unit of analysis, emerged AFTER WWII, developed by biz school profs, explain intra-industry trade)  

Firm-based theories developed later as MNCs rose to power in mid-20th century. Attention shifted to the firm’s role in promoting i-trade Useful in describing patterns of trade in differentiated goods for which brand name is an important part of customer’s purchase decision

Firm-based theories developed for 2 reasons: 1. Growing importance of MNCs 2. Can Explain & predict existence & growth of intra-industry trade (that accounts for 50+% of world trade) Country-level can only explain inter-industry trade e.g. Jap and Germany automobile industries trade diff cars with each other, involves trade in differentiated goods, brand names involved when explaining trade flows, incorporate factors such as:    

Quality Technology Brand names Customer loyalty

Newer theories explore the firm’s role in promoting exports & imports because firms, NOT countries are AGENTS of i-trade

4 theories (country similarity theory, PLC, global strategic rivalry, national CA) 1. Country similarity (Linder’s) theory a. Trade b/w 2 countries of goods within SAME industry = INTRA-industry trade b. Linder’s theory has 2 key elements i. International intra-industry trade in manufactured goods results from similarities of pref. among consumers in countries that are at the same stage of econ devt  Firms initially manufacture goods to serve domestic mkt, BUT as they begin to export ii. Suggests that most trade in manufactured goods should be b/w countries with similar per capita income  Esp useful in explaining trade in differentiated goods e.g. cars 2. Product life cycle theory (next 3 theories -> how develop, maintain, & possibly lose CA) a. General PLC theory

i. States that best location for devt, production & marketing of certain goods & services shifts over time as these goods passs through states of market introduction, growth, maturity, & decline b. International PLC theory i. Harvard prof Vernon described (in 1960s) an evolutionary process applicable to MNCs as they develop, produce, & market products worldwide ii. 3 stages (tech innovations developed in developed countries with abundant capital & skilled labour) iii. New product stage  Firm develops & introduces an innovative pdt, responding to a perceived need in the domestic market e.g. BB in Canada, Sharp in Japan  New pdt’s manufacturing is initially domestically in the innovating firm’s country for 4 reasons a. R&D requires highly skilled knowledge workers b. Market feedback – firm must closely monitor customer reactions to ensure pdt satisfies needs c. Firm usually minimize its investment in manufacturing capacity for pdt, coz size of potential mkt is uncertain d. Most o/p initially is sold in domestic mkt with limited exports iv. Maturing pdt stage  Dramatic increase sales DD (domestic & foreign)  Manufacturing expands domestically, some goes to emerging/developing countries  Domestic & foreign competitors emerge lured by potentially large profits e.g. BB faces apple, android v. Standardized pdt stage (mkt stabilizes)  Production becomes standardized & monopoly power dissipates  Price becomes key, profit margins shrink & pdt becomes a commodity  Effects: manufacturing shifts internationally, innovating country & firms begin to import & sometimes stop domestic production  Imitators may enjoy CA in production & export of mature pdt (since they have no R&D costs + lower labour costs) c. Study PLC from view of innovating firm’s country, other industrialized/developing countries, & d. Limitations of PLC theory (will be tested) i. US, EU, japan no longer sole innovators of pdts in the world, new pdts from even emerging countries e.g. SK Samsung as R&D activities globalize ii. Today firms design new pdts & modify existing pdts very quickly  Globalisation & tech shortened cycle from innovation to growth to maturity, explains rapid global spread of new consumer electronics iii. Firms introduce pdts in many mkts simultaneously to recoup R&D costs before sales decline iv. More firms are born global facilitated by internet 3. Global strategic rivalry theory a. Helpman, krugman, Lancaster (1970s & 1980s) examined intra—industry trade in context of BOTH global strategic rivalry of MNCs i.e. strategic decisions MNCs adopt to compete internationally & its effects on flows of i-trade & investments

b. This view argues that MNCs struggle to develop some sustainable CA, an advantage that provides firms with ability to dominate global mktplace c. 4 ways to develop sustainable CA i. Own IPR (trademark, brand name, patent, copyright)  Gains advantages, charge premium prices (prestige, brand names) ii. Invest in R&D  R&D is a major component of total cost for firms seeking to be competitive in industries that produce high-tech pdts. These large “entry” costs make other firms often reluctant to compete against established firms  E.g. aviation, semi-con, pharmaceutical  May gain FIRST-MOVER advantage a. It’s the economic & strategic advantage a firm gains by being 1st firm to enter an industry. Creates a BTE for potential rivals & may allow a firm to dominate [Note: gov may help home-based companies] b. EU is large exporter of commercial aircraft coz of Airbus (consortium owned by france, Germany, UK etc) c. Netherlands = world’s largest flower exporter by investing in new tech i. Aalsmeer flower auction involves 5000+ growers & 1300+ buyers, becomes centre for trade in flower futures, integrated e-comm into auction system s.t. auctions are monitored & orders placed w/o having to travel to Amsterdam iii. Achieve EOS & economies of SCOPE (number of diff pdts that firm sells increase)  Permits firms to enjoy falling AC  Effect of declining costs: force competitors to produce at similar level of o/p to be competitive iv. Exploiting experience curve  Firms that successfully exploit learning curve gains CA, as production costs decline as gain more exp in manufacturing 4. Porter’s national CA theory (2 steps: corporate & national CA) a. Context: step 1 => Corporate CA i. CA of a successful corp = reasons that allow it to make more profits as compared to the ‘marginal’ company that is just managing to survive ii. Individual firm has CA when it possesses 1 or more sources of distinctive competence relative to others allowing it to perform better than its competitors iii. Reasons more successful firms have corporate CA include:  Architectural – benefits to firm from some distinctive aspects of contractual relationships the firm has entered into with suppliers &/or clients e.g. Walmart’s low-cost ops  Innovation – benefits to firm from being more innovative than rivals (perhaps reinforced by legal struturecs e.g. patents), e.g. Apple’s superior tech design b. Context: step 2 => National (for countries to enhance) CA i. Globalization of mkts has fostered a new type of competition – a race among countries to reposition themselves as attractive places to invest in & do biz ii. Initiated proactive policies designed to create CA

iii. Focus is on developing acquired advantages in world-class economic sectors & prosperous geog regions iv. CA of a country depends on collective CA of its firms v. Over time, this relationship is reciprocal e.g. Japan as a country possesses national competence & competitive advantage in high-tech electronics industries coz it’s home to high-tech electronics firms. Japan’s national CA in high-tech electronics fields has driven devt of new firms & industries in these fields vi. E.g. UK has national CA in pharm (GSK, AstraZeneca), US in service industries (Goldman Sachs, Dreamworks, Accenture), Germany in engineering-intensive (BMW, Volkswagan/audi) c. Context: innovation (BOTH pdt & process) i. Innovate by continually searching for new & better products, processes, services, marketing approaches ii. Innovation = what’s desirable, viable, and possible with tech  sustains firms’s CA iii. The greater a country’s aggregate innovative capacity, the more the country’s CA iv. Effects of innovation  Promotes improved productivity i.e. o/p per worker  Productivity is key factor determining the country’s LR SOL (incl. increasing GDP/person)  GDP/person reflects productivity levels of diff countries d. Porter’s DIAMOND of national CA i. Explains how i-trade grows depending on the CA at BOTH country & firm levels ii. 1st: country’s competitiveness in an industry depends on industry’s capacity to innovate & upgrade iii. 2nd: in turn, this depends on presence & quality in a country of following 6 major elements: 1. Factor conditions a. Country’s endowment of FOP affects its ability to compete internationally (BASIC & ADVANCED factors) b. Basic: natural endowments e.g. labour, land, natural resources, oil, copper, i. Consistent with Heckscher-Ohlin theory, every country has more of certain factor conditions ii. Porter’s theory says that basic factors can spark initial production c. Advanced: capital, tech know-how, entrepreneurship (all result from innovation education system) i. Account for country’s sustained CA in a pdt ii. E.g. abundance of workers that are cost-effective & educated gives china CA in production of laptops & smartphones iii. Abundance of strong engineers gives Germany CA in engineering & design iv. Labour efficiency – pay & productivity (SG, HK top 2, US 9th) v. Labour efficiency – hiring & firing (UK 49th, france 126th, Germany 133th coz of unions) vi. Capital – quality of overall infrastructure e.g. roads, railroads, electricity, telecomm (US 23rd, canada 13th, HK SG 2nd 3rd ) vii. Tech – capacity for innovation (Germany Japan top 2, US 6th, canada 19th) viii. Tech – quality of scientific research institutions (UK, US, Sweden, Germany 3rd – 6th) ix. Tech – company spending on R&D (Japan, ) 2. DD conditions

a. Refers to the size, strength & sophistication of home-market DD for specific goods & services with which the firm must deal b. The presence in the country of many, highly demanding, sophisticated customers pressures firms to innovate more quickly & produce better products c. Effect: facilitates devt of CA in particular industries d. E.g. Japanese firms have CA internationally since at home they have sophisticated & welloff consumers willing to buy (&test) before fine-tuning & sold to the world 3. Firm strategy, structure, rivalry a. The domestic environment in which firms compete shaping their ability to compete in international markets b. Refers to conditions in a country that decide how firms are created, organized & managed, refers to nature of domestic rivalry c. Presence of strong competitors in country helps create & maintain a national CA d. E.g. If face vigorous competition at home, will be forced to continuously reduce cost, raise productivity, improve quality, more innovation e. Many of investments firm make to succeed in domestic mkt are transferable to international mkts at low cost e.g. Italian design industries f. Intense domestic home competition partly explains international success of Jap & German auto makers, US film studios g. Goods: market efficiency (extent of mkt dominance)  Germany, Japan (few firms dominate) h. Goods: degree of customer orientation  Japan highly responsive to customer DD 4. Related & supporting industries a. Emergence of an industry often stimulates devt of local suppliers eager to meet that industry’s production, marketing & distribution needs i. Industry located close to its suppliers will enjoy better comm & exchange of costsaving ideas & inventions with those suppliers ii. “competition among these input suppliers leads to lower prices, higher-quality products & tech innovations in input market” iii. In turn, reinforces the domestic “industry’s CA in world markets”  relate this concept to that of INDUSTRIAL CLUSTERS e.g. silicon valley, great place to launch software firm b. Local supplier quantity + quality c. INDUSTRIAL CLUSTERS i. Porter’s theory also explains “regional clustering” of suppliers, competitors & complementary firms “within an industry” ii. Regional clustering results from Agglomeration Econs (which occur when firm’s cost of production decline as no. of firms in that industry increases within a given area), such growth attracts additional input suppliers to the area, which then increases price competition & innovation among those suppliers. As their customer base increases, suppliers can specialize, developing unique abilities that benefit cluster as a whole

iii. Clusters also promote innovation & entrepreneurship iv. Competition is intense & firms must continually improve products & productivity to survive v. DEFINITION: a concentration of biz, suppliers & supporting firms in same industry located in same geog area. Characterized by critical mass of human talent, capital or other factor endowments. vi. Firms that operate within this mass of related & supporting industries secure advantages through: info & knowledge synergy, EOS/scope, access to appropriate/superior inputs vii. Orgs in the cluster: specialized raw material component services providers, financial agencies, companies in related industries, unis & research institutes, final product manufacturers viii. Strong cluster can serve as country’s export platform e.g. silicon valley, Bangalore, Switzerland (fashion), Italy (fashion), Pusan SK (footware) ix. Knowledge is only source of sustainable LR CA, future national wealth goes to those who invest most in R&D, education & infrastructure that support knowledge-intensive industries d. National industrial policy i. Implements a pro-active econ devt plan, often with private sector coop. objective of gov’s plan is to develop &/or support promising industry sectors that have potential for regional or global dominance ii. Rationale for NIP: porter’s diamond model suggests that NATIONAL CA does not rely only on INHERITED factor endowments as it can be ACQUIRED by systematically developing new/superior factor endownemnts iii. Countries can develop these endowments through a proactive NIP iv. NIP’s focus on high value-adding industries 1. Encourages econ devt &/or support of such industries that generate superior corp profits, higher worker wages & tax revenues 2. Historically have favoured more traditional e.g. autos, shipbuilding, heavy machinery [1970s)  perceived benefits: generate substantial added value, revenue, help devt of suppliers that further enhances national prosperity v. Typical elements of NIP 1. Gov creates tax incentives to encourage citizens to save & invest 2. Emphasizes fiscal & monetary policies that provide substantial & stable supply of capital for investment needs of firms 3. Rigorous educational systems are fostered at pre-college & uni level 4. Investments are made to build a strong national infrastructure in areas such as IT, comm, transportation 5. [SINGAPORE] 1960s gov adopted pro-biz/investment, export-oriented policies combined with state-directed investments in strategic corps, cut

taxes, gov spending, encouraged FDI in high-value industries (electronics, chemical, engineering) 6. [VIETNAM] 1990s gov privatization modernized economy, emphasized competitive export-driven industries, increased exports of EVERYTHING, modernized IP regime, entered FTA, revamp educational system to get skilled workers, built infrastructure 7. [DUBAI] want to focus on IT, biotech, financial, & other KBE 5. Gov policies (nature of regulatory environment, extent of state intervention, state support for educational & vocational training etc) a. 6. Chance (luck)

Chapter 5 part 2: FDI Objectives 6: summarize how SS, DD, & political factors influence FDI

Context: how do firms internationalize?   

Internationalization process model developed in 1970s Occurs in incremental stages over a long period of time Shows stages as firm goes from solely domestic to international

Trade & investments may be substitutes or complements, 2 options: 1. Internationalization via trade 2. Internationalization via FDI Stages in company internationalization Domestic focus  pre-export stage. Typically firms start w/o much analysis & begin to study export since it’s simplest form of international activity. The gradual & incremental nature of internationalization often results from managers’ uncertainty & uneasiness about how to proceed, coz they lack BOTH info about foreign mkts AND exp with cross-border transactions Pre-export  experimental involvement (testing water)  active involvement. Firm realizes potential benefits of exporting, creates systems for & dedicates resources to exporting Pre-export  experimental involvement  active involvement  committed involvement. Decides to stay involved permanently & exporting becomes integral part of coy

Early theories (1970s) – believed that firm would progess in internationalizing in cremental stages over a long period of time Recent theories – slow & gradual assumption is not always accurate (BORN GLOBAL)

FDI  more developed form of internationalization     

FDI makes firms into MNCs & helps them gain international CA Been MNCs’ main strategy in internationalization Occurs when a firm invests directly in new/existing facilities to produce &/or mkt products in a foreign country Once firm undertakes FDI  MNC Controversy: 2 edged sword to host country o Benefits: FDI increase productivity, employment & wage rates o Costs: FDI may cost control of country’s economy,

Objective 4: Describe & categorize diff forms of international investment 2 categories of investment that rest on question of CONTROL 1. Seek active management role in firm (FDI)  obtain degree of control in firm a. Acquisition of foreign assets for purpose of control b. Gov consider FDI as 10-25% of stock ownership or control in foreign firm c. Forms of FDI: buying existing assets, new investment in PP&E, participate in joint venture 2. Seek return from passive investment (FPI)  does not involve obtaining degree of control a. Rep passive holdings of securities e.g. foreign stocks, bonds b. Seek BOTH attractive return & risk reduction via diversification Growth of FDI Trend: steepened in last 20 years, increased in all major country groups incl developing Direction of FDI – recipient countries Dramatic growth of inward FDI in past 30 years. US 1st, China 2nd, HK 3rd, Brazil 5th, Germany 6th, UK 7th, Russia 8th, BUT CUMULATIVE china is 1st, Russia 2nd, brazil 3rd. 1st 6 months of 2012, china beat US, hk is 3rd  china is FAR superior than US, while developing/emerging economies received 50% of all FDI, matching the developed world Direction of FDI – source countries Total outward FDI stock constitutes 1/3 of global GDP US 1st, UK, france, Germany, HK, Netherlands, Japan. Emerging markets firms have greatly increased their FDI investments in recent years China acquiring energy & resource companies in Canada, Africa, Latin America etc

USA: many state-owned Chinese biz rebuffed by US gov when trying to buy US firms that control natural resources/advanced tech Effect: Chinese have been non-controversial with US acquisitions Single largest Chinese investment in US is……movie theaters e.g. AMC theaters, Cineplex Chinese investment in US in 2012 = $6.5b, US was single biggest recipient of Chinese FDI, but this is still relatively small compared to size of US economy. $54b compared to 60trillion FDI shifting away from extractive industries & manufacturing & towards SERVICES, driven by 4 factors: 1. 2. 3. 4.

Developed countries increasingly produce services Many services must be produced where they are consumed Liberalization of policies governing FDI in services Rise of internet-based global telecomm networks

FDI in US in textbook not required