BUS685:2 Chapter 2International Trade & Foreign Direct Investment

International Trade and Foreign Investment This is a descriptive chapter giving a snapshot

of patterns of global trade and investment. There are too many tables and figures but we

look for only broad patterns and to the extent data and figures that are necessary.

Focus on only those headlines, topics covered in the class.

Data is updated to 2007

1. International Trade Volume of Trade

The volume of international trade in goods & services combined together increased by fourfold from 1990 to 2007. In 1990, it was $4 trillion, in 2007, it stood at $17 trillion.

Dollar value of total global exports was greater than GNP of every other nation than USA.

Exports of merchandise ($13.9 trillion) was also about four times that of services ($3.3 trillion) and it was nearly seven times that in 1970.

1. International Trade Regional Pattern of Trade

Despite an absolute increase in dollar volume of trade for all regions, there were variations in regional performance.

The proportion of exports coming from North America, Latin America, Africa, and Middle East decreased between 1980 and 2007, for example, Africa’s exports declined by half.

In contrast, proportion of merchandise exports from Asia increased by 88%, China accounting for 63% of that increase.

Regional Pattern of Trade contd…

EU’s share also marked modest increase, the increase was due to expansion of EU from 15 to nearly 30 countries.

The proportion of exports of commercial services from Latin America, EU, Africa and the Middle East marked decline since 1980, with the exception of USA which marked increase by 32%

Asia’s share in service exports increased from 13.7% to 22.9%.

Regional Pattern of Trade contd…

As far as proportion of manufacturing value added in developed countries has declined across most industrialized sectors between 1995 and 2006.

Correspondingly, developing countries’ share of value added has increased with wide variations

between regions – Africa and Latin America’s share declined while South and Southeast Asia’s share increased four folds since 1980.

What is the relevance of all these trends for business managers? [see page 37, para 3]

International Tradeo Which nations account for the most exports

and imports?• The largest exporters & importers of

merchandise & services are generally developed countries.

• Some emerging economies like China, India, Malaysia also rank among the leaders.

Which nations account for most of the trade?

o Table 2.3 – page 39o Leading merchandise exporters

o Germany tops the list of merchandise exporters with an export value of $1,112 billions, accounting for a share of 9.2% of world goods’ exports.

o Other notable European countries among the top 10 exporters are France, Netherlands, UK, Italy & Belgium.

o USA is ranked 2nd with an export value of $1,038 billions. o China is the leader among Asian countries with a share of

8%, ranking at 3rd place.o Japan comes right after China with a share of 5.4% of world

exports of goods.

Which nations account for most of the trade?

o Table 2.3 – page 39o Leading merchandise importers

o The combined share of the leading 5 importing nations is 38.9% of total world merchandise imports.

o USA, ranked 1st, has an import value of $1,919 billions that amounts to 15.5% alone.

o India, whose imports are valued at $175 billions appears in this list with a share of 1.4% of world goods’ imports.

Which nations account for most of the trade?

o Table 2.3 – page 39o Leading service exporters

o Developed countries like USA, UK & Germany lead this list of service exporters with a combined share of 28.5% of world exports of services.

o Countries like Canada & South Korea go down the list, appearing at 14th & 20th place respectively, indicating that their trade in merchandise is higher than their trade in services.

o Other nations like Denmark & Luxembourg show up with exporting values of $52 billions & $51 billions respectively.

Which nations account for most of the trade?

o Table 2.3 – page 39o Leading service importers

o This list is similar to that of the service exporters, dominated by USA, Germany & UK.

o The leading service importers from Asia include Japan, China, South Korea & Hong Kong, with a combined share of 13.2% of world service importers.

o India appears in this list at 13th place, demonstrating that it imports services more than it exports.

Direction of Trade More than half the exports from developing

nations go to developed countries. However this proportion has been declining over

the past 35 years, from 72% in 1970 to 50% in 2006.

More than 70% of developed economies’ exports go to other industrialized nations, and not to developing countries.

Direction of Trade Japan, along with USA. is an exception to this

pattern. A large portion of their exports go to developing

nations. Many Japanese companies have moved

manufacturing operations to lower-cost nations, producing substantial “reverse imports” to Japan itself.

Direction of Trade

American firms have significant subsidiaries in developing nations.

These subsidiaries are captive customers for their US owners.

As a result, compared to other developed nations, USA exports a smaller proportion to other developed countries and more to developing nations.

Increasing Regionalization of Trade Emergence of regional trading arrangements like

ASEAN, EU, NAFTA, has significantly altered global trading patterns.

For example, most of Canada’s exports go to USA because of NAFTA.

There are more than 200 trading agreements in operation worldwide and their share in world trade increased from 37% in 1980 to 60% in1990 and more than 70% in 1990.

Question on globalization & WTO principles?

2. Foreign Investment Foreign investment has two main

components:1. Portfolio investment – purchase of stocks &

bonds to obtain return on the invested funds2. Direct investment – investors also manage the

firm in addition to

2. Foreign Investment Foreign investment can be divided into two components:

portfolio investment and foreign direct investment (FDI) Portfolio investment

Portfolio investors often invest huge amounts in stocks & bonds from other countries.

By foreign direct investment, investors participate in management of firms in addition to receiving returns from the investment.

This can happen by fresh or green buck investment in plant or by merger/acquisition of existing firms or by buying stock, usually upto 10%

2. Foreign Investment Volume of stocks of outward FDI (figure 2.2 – page 45)

Developed economies - less than $1000 billions in 1980, increased to more than $10,000 billions in 2006.

USA – doubled to approx. $400 billions by 1990 that surpassed $2,000 billions by 2006.

European Union – increased from about $3,000 billions in 2000 to approx. $6,000 billions in 2006

Developing economies as a whole – still less than $2,000 billions as of 2006 data

2. Foreign Investmento Does trade lead to FDI?

• Historically there has been a linear path to market expansion by which FDI has followed foreign trade.

• Engaging in foreign trade is less costly & less risky.

• Besides it is easier to expand the business in small steps.

2. Foreign Investmento Does trade lead to FDI?

• Also, managers keep an eye on the total market size to see if there is any chance of benefiting from increased manufacturing in case of increased market size.

• Now-a-days many international firms can disperse their activities because of fewer government barriers to trade, increased competition from globalizing firms and availability of new technology.

2. Foreign Investmento Does trade lead to FDI?

• The firms then integrate the whole production process either regionally or globally.

• Thus the decision regarding the location of may be either an FDI or a trade decision.

• This illustrates how closely FDI and trade are interlinked.

3. Why Enter Foreign Markets? Two main reasons: A. Increase profits & sales B. Protect market, sales and profits A. Increase profits and sales

o Enter new markets When the market gets saturated the managers

search for opportunities outside their home country, where: GDP & population growth are rising Growth rate is higher than the home country

3. Why Enter Foreign Markets? New Market Creation

By new market creation, we mean exploring and assessing new market opportunities in countries where the firm has not yet ventured.

Exploration usually takes place first by consulting secondary data base like UNDP HDR, World Bank and IMF country data to assess which economies are emerging in terms of rising population, GDP growth rate, literacy, HDI, availability of raw materials, and the like. Closer market exploration and assessment follows after these preliminary explorations.

3. Reasons for entering Foreign Markets

New Market Creation: From a macro perspective markets around the

world are growing, as indicated by the Human Development Report.

However, this does not ensure that opportunities for all kinds of business are equally good.

Regional Cooperation through PTA/FTA

These arrangements, such as EU, ASEAN or NAFTA increase the market size significantly.

3. Reasons for Entering Foreign Markets

Faster-Growing Markets Firms looking to increase their scope of

production are attracted by foreign markets that grow at a faster rate than the home country.

Government barriers to import make imports less competitive and allows local producers to grow.

3. Reasons for entering Foreign Markets

Improved Communications Better communication technology allows the

managers to control foreign operations more easily.

It allows “off-shoring” of work, which is becoming more popular.

3. Reasons for entering Foreign Markets

Obtain greater profits Greater revenue – as firms move toward

greater globalization of their operations, their sales volume increase while lowering the cost

Lower cost of goods sold – economies of scale, like reduced R&D costs, and government offers to attract new investment all lower cost of production

3. Reasons for entering Foreign Markets

Obtain greater profits Higher overseas profits as an investment

motive – according to McKinsey estimates US companies made profits totaling $2.7 trillion from overseas operations

Test Market Sometimes an international firm test-

market a product in a foreign market to make changes, if necessary

3. Why Enter Foreign Markets? B. Protect Markets, profits and sales

Protect domestic market Follow customers overseas

Attack in competitor’s home market Using foreign production to lower costs Protect foreign markets

Lack of foreign exchange Local production by competitors Downstream markets Protectionism

Guaranteed supply of raw materials

3. Why Enter Foreign Markets? B. Protect Markets, profits and sales

Guaranteed supply of raw materials Acquire technology & management know-

how Geographic diversification Satisfy management’s desire for expansion

5. Multi-domestic or Global Strategy? Seven global dimensions

1. Product2. Markets3. Promotion4. Where value is added to the product5. Competitive strategy6. Use of non-home-country personnel7. Extent of global ownership in the firm