FACULTY OF ECONOMICS

Kardan University

International Economics
Chapter 09: International Resource Movements and
Multinational Corporations
Book by: Dominick Salvatore
John Wiley & Sons, Inc.
Ahsanullah Mohsen M.Sc.
a.mohsen@Kardan.edu.af
Ahsanullah.Mohsen@rub.de

1
Kardan.edu.af
 FACULTY OF ECONOMICS

In this chapter:

1. Introduction
2. Some Data on International Capital Flows
3. Motives for International Capital Flows
4. Welfare Effects of International Capital Flows
5. Multinational Corporations

Salvatore: International Economics, 10th Edition

© 2010 John Wiley & Sons, Inc.
 FACULTY OF ECONOMICS

1. Introduction

• International trade and movement of productive resources are

substitutes.
• As with trade, the movement of resources between nations tends to
equalize factor returns.
• Two main types of foreign investments:
• Portfolio investments
• Direct investments

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FACULTY OF ECONOMICS

1. Introduction

• Portfolio Investments
• Purely financial assets, such as bonds or less than 10% of voting stock,
denominated in a national currency.
• Take place primarily through financial institutions such as banks and
investment funds.
• Direct Investments
• Real investments in factories, capital goods, land and inventories where both
capital and management are involved and the investor retains control over
use of invested capital.
• Usually takes form of a firm starting a subsidiary or taking control of another
firm.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FACULTY OF ECONOMICS

Motives for International Capital Flows

• International Portfolio Investments
• The basic motive for international portfolio investment is to
earn higher returns abroad.
• Portfolio theory tells us that by investing in securities with
yields that are inversely related (like foreign and domestic
securities) over time, a given yield can be obtained at a
smaller risk, or a higher yield can be earned with the same
level of risk for the portfolio as a whole.

• So a portfolio including both domestic and foreign securities

can have a higher average yield and/or lower risk than one
containing only domestic securities.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FACULTY OF ECONOMICS

Motives for International Capital Flows

• Direct Foreign Investments
• The basic motive for direct foreign investment is to earn
higher returns (possibly from higher growth rates abroad,
more favorable tax treatment or greater availability of
infrastructure) and to diversify risks.
• Large corporations often have unique product knowledge
or managerial skill that could easily and profitably be used
abroad and over which the corporation wants to retain
direct control.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FACULTY OF ECONOMICS

Motives for International Capital Flows

• Direct Foreign Investments
• Horizontal integration is
the production abroad of a
differentiated product that is also produced at
home.
• Vertical integration (backward)
allows a corporation to
obtain control of a needed raw material and thus
ensure uninterrupted supply at lowest possible
cost, or acquire later stages in the production
process, or ownership of sales or distribution
networks abroad (forward).
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FACULTY OF ECONOMICS

Vertical integration: offshoring

© 2008 Worth Publishers ▪ International Economics ▪

Feenstra/Taylor
 FACULTY OF ECONOMICS

Motives for International Capital Flows

• Direct Foreign Investments
• Also done to avoid tariffs and other restrictions that nations impose on
imports, or to take advantage of government subsidies encouraging direct
foreign investment.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FACULTY OF ECONOMICS

Welfare Effects of International Capital

Flows: Benefits of FDI
 Resource Transfer
 Stable source of foreign capital
 Advanced technology
 Advanced management skills
 Creation of employment opportunities
 Stronger competition
 Domestic market becomes more efficient with stronger competition among firms
 Positive effects on Balance of Payment (BOP)
 Capital inflow with initial FDI
 When the goods/services produced by the FDI substitute for imported
goods/services
 When the goods/services produced by the FDI are exported to another country
 Economic growth
 To some extent, FDI may help the economy grow faster
10
 FACULTY OF ECONOMICS

Welfare Effects of International Capital

Flows: Costs of FDI
 Adverse effects on competition
 Foreign firms (MNEs) may have too much power and kill off competition

 Adverse effects on BOP

 After initial inflow of capital, subsequent outflow of capital from the
earnings of the FDI
 Import inputs from abroad for the foreign firms

 Weakening of national sovereignty

 Possible loss of economic independence as some decisions that affect the
host country’s economy may be made by a foreign company that has no
real commitment to the host country

11
 FACULTY OF ECONOMICS

Multinational Corporations
 Multinational corporations (MNCs) own, control,
or manage production and distribution facilities
in several countries.
 Today, MNCs account for about 25% of world
output, with intrafirm trade estimated at about
one third of total world trade in manufacturing.
 Most international direct investments are
undertaken by MNCs.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FACULTY OF ECONOMICS

Multinational Corporations
 Reasons for MNCs
 Integration may increase profits through better
control of supply chains.
 The larger scale of production may allow the firm to
better exploit economies of scale.
 MNCs can better direct production to low cost
nations.
 MNCs can artificially change prices to only show
profits in low tax nations (transfer pricing).

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FACULTY OF ECONOMICS

Multinational Corporations
 Problems in Home Country
 Loss of domestic jobs to other countries.
 MNCs may move technology out of the home
country reducing the technological advantage of
the home country.
 Transfer pricing may reduce taxable income and
tax revenue.
 Access to foreign markets allows MNCs to bypass
domestic monetary and fiscal policy control.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
 FACULTY OF ECONOMICS

Multinational Corporations
 Problems in Host Country
 MNCs are assumed to dominate their
economies.
 R&D funds are drained off to the MNC’s
home nation, keeping host nation
technologically dependent.
 MNCs may extract from host nations most of
the benefits of their investment, either through
tax and tariff benefits or tax avoidance.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.