Week 6: Lectures 11-12 - Multinationals (MNEs)

Question 1

Briefly explain the importance of Multinationals (MNEs)

Answer 1

• The value added of MNEs accounts for 25% of world GDP
• In developed countries MNEs are responsible for 20-25% of the country’s labour force
  70% of world business R&D is produced by the 700 largest multinationals

Question 2

What is a MNE?

Answer 2

• A Multinational (MNE) is an enterprise operating in several countries but is managed from one (home) country
• Generally any company that derives a quarter of its revenue from operations outside of its home country is a MNE

Question 3

Is a MNE different from foreign direct investment (FDI)?

Answer 3

MNE is different from FDI:
- FDI refers to an investment made by a company based in one country into a company based in another country

Question 4

What is the legal entity that owns a firm abroad called?

Answer 4

• The legal entity that owns the firm is called the parent company
• The company abroad is called the subsidiary or the affiliate

Question 5

Differentiate between Greenfield and Merger and acquisition (M&A) in terms of types of MNEs

Answer 5

• Greenfield MNEs refer to the creation of a new subsidiary abroad
• M&A MNEs refer to buying an existing foreign firm

Question 6

Explain the difference between horizontal and vertical MNEs

Answer 6

• Horizontal MNEs: Horizontal MNEs are when the company carries out the same activities abroad as at home. Eg. Toyota assembles cars in the US and in Japan
• Vertical MNEs: Vertical MNEs are when different activities are carried abroad than at home. Eg. Intel’s assembly plant in Costa Rica

Question 7

Explain the difference between backward and forward oriented MNEs

Answer 7

• Backward oriented MNEs are those in which the subsidiary is the supplier of the parent company
• Forward oriented MNEs are those in which the parent company is the supplier of the subsidiary

Question 8

Where in the world is MNE activity mostly concentrated?

Answer 8

MNE activity is concentrated in developed countries

Question 9

Compare parent and subsidiary companies to domestic firms

Answer 9

Parent and subsidiaries tend to be larger, more productive, R&D intensive and export oriented than domestic firms

Question 10

Explain why MNEs exist using the OLI framework (Hymer 1965)

Answer 10

The main three reasons as to why MNEs exist are:
- Ownership
- Location
- Internalization

Question 11

Explain why MNEs exist using the OLI framework (Hymer 1965) in terms of ownership

Answer 11

• Ownership: MNEs hold firm specific assets that allow firms to compete in unfamiliar environments
• These include proprietary technology that provides market power or cost advantages over other producers

Question 12

Explain why MNEs exist using the OLI framework (Hymer 1965) in terms of location

Answer 12

• Location: MNEs allow the efficient exploitation of firm’s assets in several countries. As the firm’s assets have high fixed costs that can be used simultaneously in different locations, this means that different parts of the production process can be undertaken in the corresponding most cost effective place
• International taxation: Multinational firms owe taxes to the countries in which they earn income and their foreign incomes are also potentially subject to taxation in their home countries. As tax rates differ significantly across locations, operations can be arranged to minimize taxable incomes in high tax countries

Question 13

Explain why MNEs exist using the OLI framework (Hymer 1965) in terms of internalization

Answer 13

Internalization: Market failures in the transfer of technology or inefficiencies associated with market exchanges of highly customized intermediate inputs

Question 14

Explain the proximity-concentration trade-off of Horizontal MNEs

Answer 14

Horizontal MNEs replicate the production processes in different countries to save on transportation costs or tariffs
- MNEs and trade are substitutes:
- Firms invest abroad to avoid trade costs (variable costs) which is a proximity benefit
- Firms prefer exporting to invest abroad to avoid duplication costs (fixed costs) which is a concentration benefit
- If export costs rise or destination markets become large then the variable costs of exports become more important than fixed duplication costs

Question 15

What has been the impact of Brexit on MNEs?

Answer 15

The impact of Brexit on FDI:
- The threat of reduced access to the EU market after Brexit has pushed UK firms into setting up subsidiaries or acquiring companies in the remaining EU member states
- Evidence of this is that Barclays, HSBC, and Easyjet along with other smaller firms such as Crust and Crumb which is a Northern Ireland pizza maker have all invested in the EU in response to Brexit

Question 16

Explain what is meant by ‘Great reallocation’

Answer 16

• The ‘Great reallocation’ refers to the US concern of Global Value chains dependence on China
• Direct US sourcing from China has decreased with low wage locations (Vietnam) and nearshoring alternatives (Mexico) gaining importance

Question 17

How are transactions that are not covered by detailed contracts or legal rules regulated?

Answer 17

• Markets and firms are alternative governance structures
• In markets there is negotiation and there can be conflicts because of disagreement
• In firms conflicts can be resolved through the use of authority. The drawback of firms is that authority can be abused

Question 18

What is the effect of MNEs on productivity?

Answer 18

• Domestic firms can learn from MNEs as MNEs have better management practices than domestic firms
• MNEs can improve the productivity of domestic firms due to spill over effects

Question 19

Explain the importance of property rights (PR)

Answer 19

Property rights (PR) are proof that internalization matters because ownership gives control in case of incomplete contracts