International Economics

By Robert J. Carbaugh
9th Edition

Chapter 10:
International Factor Movements
and Multinational Enterprises

Copyright 2004, South-Western College Publishing

Factor movements & multinational enterprises

Factor movements
International movement of factors of
production (capital, labor) is a substitute for
international trade in goods
International capital flows (investment) can
substitute for trade in capital-intensive
goods
Labor mobility can substitute for trade in
labor-intensive goods
Carbaugh, Chap. 10

Factor movements & multinational enterprises

Multinational enterprises
Various business operations in numerous
host countries
Headquarters often far from operations
Stock ownership and management are
usually multi-national
Frequently employ vertical integration,
horizontal integration, conglomerate
structure
Carbaugh, Chap. 10

Multinational enterprises

Foreign direct investment

A foreign or multinational firm can buy a
controlling interest in a local firm
Buy or build new plants or equipment
overseas
Shift funds abroad to expand a subsidiary
Reinvest the earnings of a foreign
subsidiary
Carbaugh, Chap. 10

Multinational enterprises

Reasons for foreign direct investment

Demand factors
Serve different local markets
Respond to market competition

Cost factors

Access to key raw materials

Labor costs
Transportation costs
Government policies

Carbaugh, Chap. 10

Foreign direct investment

Choice between export and FDI

Carbaugh, Chap. 10

Foreign direct investment

Choice between licensing and FDI

Carbaugh, Chap. 10

Multinational enterprises

International joint ventures

Two companies can operate a venture in a
third country
A foreign firm can work with a local
company
A foreign firm can form a venture with a unit
of the local government

Carbaugh, Chap. 10

Multinational enterprises

Reasons for international JVs

Cost sharing - R&D, capital expenditures
(in mining and oil, for example)
Avoiding restrictions on foreign ownership
of local firms (ensuring local participation)
Forestalling pressure for protectionism
Problems: divided control means success
of JV depends on ability of firms to work
together
Carbaugh, Chap. 10

Multinational enterprises

Effects of an international JV

Carbaugh, Chap. 10

10

Multinational enterprises

Controversy over multinationals

Employment
Host country may not gain many jobs, foreign
managers often brought in; source country
worries about losing jobs

Technology transfer
MNEs are reluctant to share technology with
host nations; source country worries about
giving away advantage
Carbaugh, Chap. 10

11

Multinational enterprises

Controversy over multinationals (Contd)

National sovereignty
Host country worries about power of MNE to
influence affairs; source country worries about
ability to regulate MNE activities elsewhere

Balance of payments
MNE investments and profits (internal
transfers) have impacts on the payments
status of both source and host nations
Carbaugh, Chap. 10

12

Multinational enterprises

Controversy over multinationals (Contd)

Taxation
Source countries may have difficulty taxing
MNE income stemming from foreign operations
Tax rate differences may discourage
investment at home

Transfer pricing
Both host and source governments worry that
MNEs may illegally manipulate prices paid
between subsidiaries to avoid taxes
Carbaugh, Chap. 10

13

Multinational enterprises

Transfer pricing illustrated

Germany

Ireland

United States

(tax rate 48%)

(tax rate 4%)

(tax rate 34%)

Computer
produced by
parent firm for
$2000. Sold to
Irish subsidiary
for $2000.

Irish subsidiary
resells the same
computer to US
subsidiary for
$2500, earning
$500 profit.

US subsidiary sells
computer at cost,
for $2500. No profit
is earned.

German tax paid:

$0.

Irish tax paid:

$20.

Carbaugh, Chap. 10

US tax paid: $0.

Irish subsidiary
then lends money
to US subsidiary
for expansion

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International factor movements

Migration
Tends to equalize wage rates between countries
Shifts distribution of income between capital and
labor
Other concerns:

Fiscal drain from immigration

Brain drain from developing countries
Impact of illegal migration
Wider gulf between skilled and unskilled workers

Carbaugh, Chap. 10

15

International factor movements

Effects of labor migration

United States

Carbaugh, Chap. 10

Mexico

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