Multinationals and world trade

University Degree Business and Administrative studies

Multinationals and

World Trade

IIB-M-001

International Trade

Student Name: Siyuan Li

Student ID: 2800712

Unit Coordinator: Nigel Grimwade

Essay Question

How has the rise of multinational company affected trade? Is Foreign Direct Investment (FDI) a substitute or does FDI complement trade?

Introduction

Multinational companies are growing dramatically and merged in many countries especially in 21th century. The rise of multinational companies facilitates word trade and economy. Many companies are engaged in Foreign Direct Investment (FDI), because it can access new overseas markets, take the advantage of cost and also to locate a business function near clusters of similar or related companies. Therefore FDI has direct link with trade. FDI has grown in importance in the global economy with FDI stocks now constituting 28 percent of global GDP (From Wikipedia). The aim of this paper is to analyze how has multinational company affected trade? And explain in some extent FDI is substitute and complement to trade.

Multinational companies are now found in many countries because these companies aim to maximize their profits. FDI and trade are clearly interlinked. Gross domestic profit allows a country to measure the outputs, and hence the effects that FDI is having upon the nation " if the unit increases, this means that the country is reaping more financial benefit from the facilitation of investments into the country, according to Romilly (2005), and the advantage of FDI is evident. The prominence of FDI clearly shows that it is successful, and that the capital flows between nations and willingness to locate subsidiaries overseas have amplified since the 1980"s as a result of its achievements. Another reason that the governments encourage FDI is the technological and management skills that the Multinational Companies can bring to the country. Multinational Companies cause an increase in technological advancements and these products then become sellable which further increases trade. (Romilly, 2005, pg 54)

Globalization has induced international trade to be easily conducted amongst nations. Previously nations had many economic barriers in order to protect their domestic products but with more Multinational Companies entering the frame has meant that such economic barriers have been lifted although protection still exist. These protections still exist in current times but at a much smaller scale. Globalization, hand in hand with improvements of technology such as the Internet, has slowly seduced nations into realizing the importance and advantages of international trade, thus leading these nations to become more open to international trade. It can be clearly seen that those developing nations that enjoying the most economic include China and India where Multinational Companies have expanded into and are enjoying contributing to trade within the country and taking advantage of low tariffs. Many argue that relationship between trade and FDI is only complementary in cases where FDI is vertical e.g. taking place in countries which are already developed and this results in low trade costs which complements FDI. Foreign direct investment has been expanding at a very fast pace throughout the past decade and recorded growths of about 40% per year from 1995-2000 but not all of this has been vertical. (Romilly, 2005, pg67) Multinational Companies based in USA which relocated from UK have embraced globalization and have been removing its trade barriers to accommodate international trade and higher levels of foreign direct investment. This has naturally caused a certain number of implications for international business enterprises based in USA. Since the early 20th century, multinational enterprises have dominated the US economy. The relationship between cross border trade and FDI is different in the service sector. If two sectors differ then relationship will turn sour. (Daniels, et al, 2002) As recent times have ushered in the world"s willingness to open up to trade and reduce its economic borders that once existed, countries are developing in a faster rate and their economies are getting stronger. Take China as an example, The country has welcome many Multinational Companies into its country with IBM leading the way. Trade and FDI have been confirmed as complements and so investing abroad had lead to more competitiveness in overseas markets, which benefits exports from the investing country. Trade and FDI such have improved the per capita income in China in recent year and the economies of scale. Foreign companies whom have undertaken its operations in China have experienced growth and success due to China's reduced trade policies and lowered tariffs. Thus it can be said in general that Multinational Companies have had an overall positive impact on foreign enterprises based in China and this will encourage more foreign direct investment and new foreign enterprises to emerge in overseas. (Daniels, et al, 2002 pg 12-20)

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The increased levels of free trade agreements since 1980's has been a result of increased levels of trade liberalization and caused by the process of Multinational Company globalization. Due to these increasing levels of free trade, that has been in Asia already achieving high rates of economic growth, UK has thus realized the importance of trade and also adopted policies to encourage free trade. Under the Washington consensus, UK established deregulation of its financial sector, dismantled trade barriers and adopted openness to overseas markets. To increase the benefits from free trade of comparative advantage, UK has also implemented the programme for competitiveness and work 1994 to increase the level of international competitiveness. (Daniels, et al, 2002) This helped the UK develop the high tech sector and has seen the level of trade gain prominence exports increase from thirty seven percent in 1970 to seventy three percent in 1999. Meanwhile imports grew to fifty four percent of GDP. This effects UK's increased international competitiveness and improved trade balance. The theoretical opinion of the location of the multinational company that engages in FDI gives rise to two separate opinions on the relationship between FDI and trade. Horizontal FDI displaces trade so they are not complementary in this case because instead of exporting, the company establishes a subsidiary abroad resulting in a trade off of low trade costs against increased fixed costs which leads to a non-monotonic relationship between FDI and trade on the basis that in spite of the fact that FDI gets rid of trade costs on the eventual product, the investing company has to accept the increased trade costs on an intermediate product. Growth of international financial flows is another feature of the new global economy. Financial deregulation has removed controls on foreign currency markets, flow of foreign capital, and overseas investment in share markets has been better enhanced by the presence of multinational companies. This has resulted in an increase in the level of exchange traded derivatives to twenty times its value in 1987 to a value of fourteen trillion in 2006. In the UK, the importance of maintaining confidence on its open financial markets is realized. Furthermore, the increased levels of technology due to multinational companies going abroad have decreased communication barriers, increasing level of world trade and decreasing the production costs. Thus, the governments of many nations have deregulated financial markets, creating openness to overseas markets and decreasing controls on capital markets. This "Industrialization by incitation" strategy was seen in 1990's as an attraction of ten percent of foreign FDI, flow to UK, helping the UK to establish an information technology sector and thus increase level of economic growth and development. Also to promote a high level of investment, the centralized wage policy has been employed. Lowered wage growth has decreased inflationary pressure and thus made it profitable to invest in the UK. Due to globalization and the effective mix of policies the British economy has increased the level of FDI into EU from US, from five percent in 80's to twenty percent in 90's. China's economy was $69.5 billion from FDI and in first quarter 2007, it has reached $15.9 billion. (National Bureau of Statistics of China 2007; Hong and Ding 2007) As one of the most successful countries in attracting FDI, the experience of absorption in foreign investment could be learned by many other developing countries. For instance, the Chinese government has circumvent tax for those foreign companies that invested more than USD10 million for the first two years and pay only 50% of their total tax in three years after the first two years. Foreign companies have the benefits on exploiting land to construct its manufacturing plant in China and during certain circumstances; the Chinese government may provide certain subsidies to foreign companies. Consequently, this has become the most attractive and successful policies for attracting FDI in China. Trade and FDI clearly complement in each in China. Whilst tariffs are low, trading becomes higher leading to more production. (Daniels, et al, 2002 pg 34)Due to multinational companies, many countries have seen an average growth of more then nine percent in 90's a fall in unemployment to four percent and a steady five percent inflation rate, an increased level of FDI and an increased exchange rate. Thus it is clear that multinational companies, through trade, investment, finance, labour market and technology has resulted in an increased level of economic growth and development in many nations.

FDI flows on an annual basis have risen from $25 billion in the 1970s to over $350 billion in 1996. As a result of this growth we have the 'restructuring' of production on a global scale concerning trade and investment with the help of technology (Globalization, Foreign Direct Investment and Technology Transfers; pp. 195-97). FDI serves as a source of 'long-term external resource flows to developing countries.' There have been many alterations and incentives in FDI geography over the last years. As a result of worldwide economic liberalization since the 1990s, regional competition has increased in reality. The privatization of companies, the local economic integration and telecommunication advances have all contributed to the evolution of FDI in terms of geography where flows have shifted and acquisition of investment information has increased. In turn, networking strategies have been developed moving away from traditional ones that enable firms to take advantage of market liberalization and the 'regional integration' by enhancing their competitiveness and competencies. Another incentive for prospects of FDI in developing countries has moved from location advantage to competitive advantage. Theories have predicted that FDI and trade are substitutes. According to the Recardian theory trade is nothing more than a substitute for factor migration. Many others argues that trade and FDI should come about due to cross country differences in factor endowments. It can be concluded that commodity trade and factor movements are indeed substitutes and this trade and FDI are negatively linked. (Daniels, et al, 2002, pg 32)FDI has increased affected trade in the following ways: First, it causes total investment to rise and attracted in turn greater levels of investment inside the host country. Second, through the technology available in the country, investment brought in from outside has proven more productive. So, the internal and local market has also been stimulated and as a result domestic investment is also increasing. This is important because it allows internal funding to circulate within the national economy, further boosting development and trade. Third, FDI has added to capital formation as a means of transferring skills and innovation with technology to the host to build marketing networks. These, have awakened local firms and pushed their efficiency. They have adopted some methods brought from outside. Finally, by making theses developing economies open and liberalized to FDI, their %GDP (in terms of growth) has risen tremendously compared to the closed economies. FDI inflows to developing countries were mainly around bank loans; however, recent trends have indicated the shift to portfolio investment due to an upturn in trade. (Daniels, et al, 2002) To sum up, Foreign Direct Investment acts as a contributor to trade and vice versa. FDI helps to develop countries both developing ones and developed ones which is either horizontal or vertical. FDI is evolving from an industrial method to a service industry globalization is playing an even bigger role in the implications of investment. FDI will continue to grow in the future as long as there are trade benefits to be gained. Countries will also welcome foreign direct investment to improve their own economy. It can be concluded that is most case FDI does complement trade but only in the correct sector and in most cases when horizontal investment is taking place. Vertical FDI results in increased costs and whilst tariffs can be low the costs of relocated are high and cannot be seen as 100% complementary. Many feel that the faster growth in FDI than trade means that FDI is more of a substitute for trade. In cases where tariff-jumping occurs when companies wish to minimise trade costs through investment of funds into a market which has high tariffs in order to challenge local producers. This is a substitute of trade. In horizontal disintegration, companies attempt to diffuse their production units to gain entry to markets in other nations so they can dodge tariffs and currency differences.

Conclusion

Foreign Direct Investment and trade are clearly interlinked and multinational companies have always been and continue to be engaged in FDI to maximize their profits. It can be concluded that is most case FDI does complement trade but only in the correct sector and in most cases when horizontal investment is taking place. Vertical FDI results in increased costs and whilst tariffs can be low the costs of relocated are high and cannot be seen as 100% complementary. Tariff-jumping occurs when companies wish to minimise trade costs through investment of funds into a market which has high tariffs in order to challenge local producers. In this case, it’s a substitute of trade.

References

Peter Romilly, 2004-2005. International Business and economic lessons, Freedom pressTrade, Growth, and Poverty by David Dollar and Aart Kraay Development Research Group, The World Bank ,June 2001International Business, 10th Edition,

Daniels, Radebaugh & Sullivan, Prentice Hall, 2002.International Business, 9th Edition,

Daniels & Radebaugh, Prentice Hall, 2001.

Foreign Direct Investment, Industrialisation and Social Change, Volume 9, Kobrin, Jai Press, 1977.

Studies in International Investment, Dunning, Pitman Press, 1970.

Multinational Companies,Volume 5 Number 3, Buckley, Enderwick & Davies, MCB Publications, 1979.

Globalisation and Business, Daniels, Radebaugh & Sullivan, Prentice Hall, 2002.

National Bureau of Statistics of China 2007; Hong and Ding 2007Globalization, Foreign Direct Investment and Technology Transfers; pp. 195-97

(access date 05/11/08)