The International Trade

Global/International Trade is the activity that occurs when a company exports goods or services to
consumers in another country.
Globalization entails two things:
o Connectivity is the existence and affordability of a communication and transportation network.
These networks or infrastructures are vital to the creation of an environment conducive to international
trade and commerce.
oEconomic interdependence is a characteristic of a society w/ a high degree of division of labor, where
people depend on each other for goods and services required to sustain life and living.
Connectivity and economic interdependence pave the way for Global/International Trade.
Globalization & The Environment
Environmentalists cite firms that relocate their operations solely for
reasons of escaping tough pollution rules in their own country. This
argument is often called lowest common denominator or race to the
bottom.
Globalization & The Social Balance
Globalization carries promises and threats, advantages and disadvantages on the national,
regional, organizational, and individual level.
A Balanced View of Globalization
Globalization infrastructure concerns institutional frameworks and market efficiency that support
fair and transparent transactions of products and services, streamline flow of commodities, capital, labor,
knowledge, information.
International transactions are activities crossing national boundaries manifested in two ways:
1. International trade: when a company exports goods or services to importers in another country;
2. International investment: when a company invests resources
in business activities outside its home country.

Definition of Key Players in International Business

1. International firm: any firm, regardless of size, that is engaged in international business.
2. Multinational Enterprise (MNE): a firm that has directly invested abroad and has at least one working
affiliate in a foreign country over which it maintains effective control.
International vs. Domestic Business
International business is the outgrowth of domestic business. As the magnitude of a firms operations
grows, it might find it profitable or necessary to build plants and facilities in other countries.

The International Trade

1. Environmental dynamics refer to the diversity that exists between countries in terms of currency,
inflation, interest rates, accounting practices, cultures, social norms, business practices, laws, government
regulations, and overall political stability.
2. Operational nature refers to differences in nature, operating principles, and managerial attitudes
across borders.

Why Firms Expand Internationally?

Market Motives
The rationale behind why firms expand internationally can basically be explained by the pursuit of
additional gains that cannot otherwise be obtained in the domestic market.
The main motives for conducting international business include market, economic,
and strategic motives.
Offensive motives are aggressive tactics like to seize market opportunities in foreign countries
through trade or investment. (E.g. Amway, Avon, and Mary Kay all entered China in the early 1990s in
search of opportunities in Chinas direct marketing business).
Defensive motives are less aggressive and often reactionary tactics in response to changing
conditions that must be adapted to in order to protect and hold a firms market power or competitive
position in the
face of threats from domestic rivalry or changes in government policies.
Economic Motives
Economic Motives are by definition, economic or pecuniary in nature.
Some of the examples of economic motives are as follows:

1. To increase their return through higher revenues and/or lower costs. This is the main reason why firms
look for countries with developing market potential and or a large population base with high per capita
income or countries with low operating costs so they can expand profit margins.

2. To benefit from differences in cost of labor, natural resources, and capital, as well as differences in
regulatory treatments of taxation between domestic-foreign countries.

Strategic Motives
Strategic Motives are mainly long-term objectives of an
internationalizing firm that are obtained through the following examples:
oTo capitalize on distinctive resources or capabilities
already developed at home such as technologies or economies of scale that can be replicated
abroad to maximize profit potential.

The International Trade

oTo be the first mover in the target foreign market before a competitor gets in.
To seek vertical integration (upstream towards the supply end, or downstream towards the
distribution end).
OTo follow its major suppliers/partners abroad.
The following are trade theories
A. Mercantilist Doctrine
B. Absolute Advantage Theory
C. Comparative Advantage Theory
D. Human Skills & Technology-Based Views
E. Product Life-Cycle Model
F. Linders Income-Preference Similarity Theory
G. The New Trade Theory

The Mercantilist Doctrine

Under Mercantilism, the Government has two goals in foreign economic policy:
1. To increase the wealth of a nation by acquiring gold. (Mercantilists identified national wealth as the size
of a nations reserves of precious metals metals which could then be used to hire mercenary armies)
2. To extract trade gains from foreigners through regulations and controls to achieve a surplus in the
balance of trade by maximizing exports (e.g. subsidies) and minimizing imports (e.g.
tariffs and quotas.
Absolute Advantage Theory further states the following things:
oThe market would reach an efficient end by itself.
oGovernment intervention in the economic life and trade relations
would be counterproductive.
oA nation would benefit from free trade simply because imports
would cost less than domestic products it otherwise would have
to produce.
Comparative Advantage Theory
a. Comparative production cost (which is further dependent on production process and state of
technology); and
b. Production factor cost (prices of land, labor, capital, etc., are in turn related to their availability in
the national economy. Economists refer to inputs to the production process as production factors. Factor
endowments are the condition (i.e. availability and cost) of factors of production.

The International Trade

Human Skills & Technology-Based Views

The Human Skills &
Technology theory adds two new factors to the explanation of
comparative advantage sources:
oHuman skills and
oTechnology gaps
Human Skills theorists explain the source of comparative advantage in terms of the comparative
abundance of professional skills and other high-level human skills.
Technology theorists argued that certain countries have special advantage as innovators of new
products. They also assume that there is an imitation lag that prevents other countries from immediately
duplicating products of an innovating country.

Product Life-Cycle Model

The four stages of the Product Life-Cycle model are:
1. Export monopoly stage wherein the innovating and exporting country have a monopoly in export
markets and proceed to build up sales with no concern for foreign competition;
2. Foreign production stage is when producers in other industrial countries start to manufacture the
product whose design and production is now standardized;
3. Foreign production becomes competitive in export markets and foreign producers start to displace the
innovating countrys exports in the remaining export markets; and
4. Original innovator becomes an importer of the no-longer new product because foreign producers
achieve sufficient competitive strength arising from economies of scale and lower labor costs.
The following are important facts related to PLC theory in trade:

The International Trade

1. Export performance of the mature, innovating country is better for new products than it is for products
reaching maturity because for obvious reasons, the competitive advantage of the innovating country lies
in the newness of the product that has not yet been copied or made by anyone elsewhere;
2. Technology is simplified as the maturing process continues, i.e. what needed skilled labor earlier on
may be produced by automation and unskilled labor later on;
3. Relationship between innovating and imitating country changes over time because if at first the
innovating country does the exporting, in the end that same country will eventually import
from imitating countries; and
4. International trade may increase in later stages of the product life-cycle as the consumer good matures
and incomes increase.
Linders Income-Preference Similarity Theory
The Swedish economist Staffan B. Linder divided international trade into
two different categories:
oPrimary products (natural resource products) and
oManufactures

The New Trade Theory

It introduces an industrial organization view into trade theory, and includes real life, imperfect competition
in international trade.
The New Trade Theory makes these following assertions:

The International Trade

1. Inter-industry trade (different industries in different nations) continues to be driven by

comparative advantage in factor endowments, while intra-industry trade (international trade in the same
industry) is largely driven by increasing returns from specialization within the industry.
2. It realizes the importance of externality in international specialization and trade. Externality occurs
when the actions of one agent directly affects the environments of another agent.
Changes in government policy, political relations between two countries, import/export history,
consumption differences between cultures, accidents and luck are all examples of externality

Service Trade
Service trade accounts for about one-quarter of global trade, and as developed countries move to
service-based economies, its share is rapidly growing.

Service trade encompasses the:

oimport/export of financial services
oinformation services
oprovision of education and training
otravel and tourism
ohealthcare
oconsulting and advisory services, etc.
Trade Measurement
Countries, firms and research institutions have common methods of acquiring, recording, and classifying
data on trade in terms of import and export statistics and figures.
Trade Balance
The balance of trade is calculated as exports minus imports of goods and services.
The Sovereignty Argument
According to this argument:
1. Shifting production to the most efficient location deprives a country that base it needs to be a viable
economy and
2. In turn, this will make a country too dependent on nations that may challenge its national interests.

The International Trade

Lowest Common Denominator Argument

Another source of opposition to free trade has something to do with the negative effects on the
environment, safety, and such. Anti-globalists are wary of Multinational Enterprises (MNEs) that shift
production activities to nations with the least protection since they will offer the lowest cost base, but in the
end, everyone suffers from the environmental degradation.
Trade Reciprocity
Although trade theories assume that much gain is made by countries that open their borders to free trade
unilaterally, additional benefits can be gained from reciprocity.
Two kinds of trade reciprocity:
1. Passive Reciprocity is the position taken by a country where it refuses to eliminate or lower its
trade barriers until the other party(ies) does the same.
2. Active/Aggressive reciprocity may be conducted through the threat of retaliation, e.g.
withdrawal of previous commitments/concessions until the other party fulfils its obligations or imposing
countervailing measures/subsidies.
Trade barriers are typically divided into two classifications:
oTariffs are official constraints on the importation of certain goods and services in the form of
total/partial limitation or a special levy;
oNon-tariffs are indirect measures that discriminate against foreign manufacturers in the domestic
market or otherwise distort or constrain trade.
Tariffs: Tariffs are surcharges that an importer must pay above and beyond taxes levied on domestic
goods and services. Tariffs are transparent and typically set ad valorem, that is, based on the value of
the product or service.
Optimal Tariff Theory - this theory assumes that by imposing a tariff, governments can capture a
significant portion of the manufacturers margin. OTT assumes two other things:
The exporter cannot raise prices at will, domestic customers will not have to pay higher prices while
their government manages to obtain part of the proceeds that otherwise would have been obtained by the
exporter;
The exporter can absorb the lower prices and will not simply shift into other markets to avoid the tariffs
altogether.
Infant Industries Argument - this is the second argument used by proponents of tariffs. This
argues that an industry new to a country, especially a developing one, needs to be protected by tariff walls
or risk being squashed by established global players before it is given a chance to grow and develop.
Quotas

The International Trade

Quotas are quantitative limitations on the importations of goods, typically spelled in terms of units (e.g.
20,000 shirts) or value (ad valorem). Some quotas allow for a preset increase, e.g. an annual increase of
3 percent or a preset decrease as contained in the North American Free Trade Agreement (NAFTA) and
World Trade Organization (WTO).
Export Controls
Export controls are a limitation typically activated against products with national security potential (e.g.
armaments) but also to dual-use products such as computers and trucks that can have both security and
civilian uses.

Dumping/Anti-Dumping
Dumping is defined by WTO as selling a product at an unfairly low price, with fair price defined as the
domestic price, the price charged by an exporter in another market, or a calculation of production costs.
Non-tariff Barriers: Non-tariff barriers are obstacles to trade, not anchored in laws and official
regulations and therefore are not transparent.
Administrative Barriers
Administrative barriers are administrative requirements or measures that are used to block the entry of
products.
Production Subsidies
Subsidies are payments provided by the government or its agencies to domestic companies in order to
make them more competitive against foreign competitors at home or abroad. The WTO distinguishes
three types of subsidiaries:
1. Prohibited Subsidies. These are subsidies that require the recipient to meet export targets or to
use domestic rather than foreign goods.
2. Actionable Subsidies. These are subsidies that are disallowed only when damage to national
interests (of the complaining country) is demonstrated.
3. Non-actionable subsidies. These include support for disenfranchised to help companies comply
with stricter environmental laws (up to one fifth the cost) and R&D assistance not exceeding one-half (for
basic research) or one quarter (for applied research) of total R&D cost. Countervailing duties cannot be
imposed on nonactionable subsidies.

Emergency Import Protection

The International Trade

Emergency import protection comes in the form of establishing quotas to allocate supply among different
exporting countries.

Foreign Sales Corporations

Foreign Sales Corporations are offshore corporations that market the products and/or services of firms in
foreign countries.
Embargoes & Boycotts
Embargoes are the prohibition on exportation to a designated country (e.g. the U.S. prohibition on
exporting to rogue states like Iran and Iraq). In contrast to export controls, embargoes are applied across
the board.
Boycotts are the blank prohibition on importation of all/some of the goods and services from a
designated country.

Technical Standards
These are provisions made by government agencies in various countries that pertain to a large array of
areas like safety, pollution, technical performance, and the like.
A group appointed by the U.S. National Research Council and headed by Gary Hufbauer concluded:
1. Standards that differ from international norms are employed as a mean to protect domestic producers;
2. Restrictive standards are written to match the design features of domestic products, rather than
essential performance criteria; there remains unequal access to testing and certification systems between
domestic producers and exporters in most nations;
3. There continues to be a failure to accept test results and clarifications performed between domestic
producers and exporters in most nations;
4. There continues to be a failure to accept test results and certifications performed by competent foreign
organizations in multiple markets;
5. There is significant lack of transparency in the systems for developing technical regulations and
assessing conformity in most countries.
Corruption is defined as an exchange between two partners (the demander and the supplier that:

The International Trade

oHas an influence on the allocation of resources either immediately or in the future, and
oInvolves the use/abuse of public or collective responsibility for private ends.
Barriers to Service Trade
Because knowledge plays a key role in a service economy, any limitation on the free flow of information,
including constraints on individual mobility (e.g. immigration controls) represent barriers to service trade.
Trebilcock and Howse state that in the absence of global standards and regulation, free trade in services
may actually result in a reduction in global welfare.

FOREIGN DIRECT INVESTMENT THEORY & APPLICATION

FDI occurs when a firm invests directly in production or other facilities in a foreign country over which it
has effective control. (Control over foreign productions or operations and the benefits that arise from
opportunities only available through actual presence in a foreign market are advantages not enjoyed by
simple exporting.)
These overseas units or entities are broadly called foreign subsidiaries/affiliates.
Two kinds of foreign direct investment
1. Manufacturing FDI which requires an establishment of production facilities.

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The International Trade

2. Service FDI which requires either building service facilities or establishing an investment foothold
via capital contribution and building office facilities.
Foreign portfolio investment/foreign indirect investment are investments by individual firms, or public
bodies in foreign financial instruments such as government bonds, corporate bonds, mutual funds, and
foreign stocks.
Types of FDI
1. Horizontal FDI occurs when the MNE enters a foreign country to produce the same product
/service that is produced at home;
2. Vertical FDI occurs when the MNE seeks:
a. Backward Vertical FDI, also otherwise known as upstream investment, when it enters a foreign
country to produce intermediate goods that are intended for use as inputs in its home country (or in other
subsidiaries) production process.
b. Forward Vertical FDI, also known as downstream investment, when it markets its homemade products
overseas or produce final inputs in a host country using home-supplied intermediate goods or materials.
Entry Modes
Entry mode is the manner in which a firm chooses to enter a foreign
market or HOW.
Examples of entry mode are:
1. International Franchising - like the ones employed by
Goldilocks Bakeshop in North America for instance;
2. Contractual / Strategic Alliances - are a cooperation between two or more independent firms
made in contractual agreement that allows each to remain independent and the same time leads to gains
for both/all like in the case of technology sharing,
3. Equity Joint Ventures - involve partnerships between two or more firms to create an independent
single entity (whose legal identity is apart from/distinct from each of the parent companys identity) to
carry out a productive economic activity and take an active decision-making role, like when Sony
partnered with
Ericsson Mobile;
4. Wholly owned subsidiaries - which involves 100% ownership by an international firm of
foreign production.
Two forms of wholly-owned subsidiaries
oGreenfield investment whereby the firm builds everything from scratch and
oCross-border acquisitions where the firm obtains an already existing subsidiary.

The following two approaches:

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The International Trade

oCross-border mergers, and

oSharing/utilizing existing facilities are forms of contractual alliance, whereby firms cooperate in order to
obtain objectives they cannot accomplish on their own, or to gain access to resources and markets they
can obtain or pursue on their own.
Strategic Logic Behind FDI
Resource-seeking FDI
Resource-seeking FDI attempts to acquire particular resources at a
lower cost than could be obtained in the home country. The different
kinds of resource-seeking FDI are the following:
1. Physical resource seeking FDI is primarily done by manufacturers of low-tech goods such as clothing,
processed foods, etc;
2. Cheap/skilled labor seeking FDI is common among both the low and high-tech industries looking for an
educated workforce from developing nations that does not command the same high wages as they do in
their home countries as is the case with semiconductor companies opening up production facilities in the
Philippines; and
3. Technological, organizational, managerial resource seeking FDI which are sought by firms looking to
boost their competitive advantage in terms of improving their processes and organizational and
managerial methods to add value to their products/services.
Market-seeking FDI
Market-Seeking FDI attempts to secure market share and sales growth in the target foreign market.
Reasons for market-seeking FDI include:
oThe firms main suppliers/customers have set up producing facilities abroad and the firm needs to
follow them overseas.
oThe firms products need to be adapted to local tastes or needs and to indigenous resources or
capabilities,
global production/marketing strategy, to maintain a physical presence in markets served by its
competitors.
Efficiency-seeking FDI
Efficiency-seeking FDI aims to rationalize the structure of established resource-based or marketing
seeking investments in such a way that a firm can gain from the common governance of geographically
dispersed activities.
The general aims of this motive include taking advantage of:
oDifferent factor endowments, e.g. the cost and availability of factors of production that incentivize MNEs
to set up operations in countries that possess abundant land, labor, capital, and
entrepreneurship;
oCultures, e.g. this is related to the psychic distance theory where companies will choose to invest in
host countries with a similar culture to its own home country because of the potentially profitable
similarities between home and host country preferences and tastes;

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The International Trade

oEconomic systems and policies, e.g. governments making economic policies that are favorable to
foreign investors such as tax breaks; and
oMarket structures. This structure refers to the state of the number of buyers and sellers of a nondifferentiated (homogeneous) product, degree of open and free information, and degree of collusion. The
pursuit of the ideal or perfect market involves the MNE looking for a host country with high information
transparency, and low collusion among industry players apart from the presence of a large number of
buyers and sellers.
Strategic asset-seeking FDI
This attempts to acquire the assets of foreign firms so as to promote their long terms strategic objectives,
especially advancing their national competitiveness.
How MNEs Benefit from FDI
Enhancing Efficiency from Location Advantages
Location advantages are the benefits arising from a host countrys comparative advantages accrued to
foreign investors. Because through FDI firms own and control actual operations overseas, they can
capture the entire profit margin that otherwise might be shared between importer and exporter.
Determinants of location choice include:
oLabor cost differentials
oTransportation costs
oTariff/non-tariff barriers
oGovernment policies
Improved Performance from Structural Discrepancies
Structural discrepancies are the differences in industry structure attributes (e.g. profitability, growth
potential, competition, abundance of buyers/sellers, free flow of information, degree of market collusion, if
any) between home and host countries.
Increased Return from Ownership Advantages
Ownership advantages are benefits derived from proprietary knowledge which refers to the knowledge
FDI occurs when a firm invests directly in production or other facilities in a foreign country over which it
has effective control or information over which the person (legal entity) developing it has ownership rights,
resources, or intangible assets possessed by the owner (MNE).
Ensured Growth from Organizational Learning
FDI creates the diversity of environments in which the MNE operates and learns from multiple stimuli,
develops diverse capabilities, and gains broader learning opportunities than are available to domestic
firms.
FDI provides learning opportunities through:
1. New practices - this mainly refers to organizational modes of practice and managerial behavior
2. New ideas that are naturally borne out of a new environment with its unique set of possibilities

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3. New cultures which can refer to both national and corporate culture; and
4. New competition from which many lessons can be learned by the organization seeking to overcome
host country challenges. These new opportunities result in the development of new capabilities, especially
for a firm with strong corporate adaptability.
FDI Impact on Host Country
Many of the factors that make FDI attractive to the host (recipient) country may make it detrimental to the
home country. Employment and Domestic Enterprise are areas in which FDI affects social welfare from
the host country perspective.
Employment
In terms of employment, host governments want to attract firms that will augment employment. However,
home governments are worried about losing such jobs. For very domestic job that is generated in the host
country, an opportunity for employment is lost to someone in the home country.
Domestic Enterprises
Resource endowments are what cause Foreign Direct Invested enterprises to be more productive than
local counterparts. This is because FDI often gives rise to enhanced capabilities among local
companies.
Current Theories on FDI
Product Life-Cycle Theory
The theory, developed by Raymond Vernon, explains why manufacturers shift from exporting to FDI. This
theory suggests that early in a product's life-cycle all the parts and labor associated with that product
come from the area in which it was invented.
The main stages
1.In the new product stage, production continues to be concentrated in the home country even
though production costs in some foreign countries may be lower. At this point, the home country innovator
seeks to expand its consumer markets by bringing its already existing product(s) abroad.
2. In the growth product stage. At this point, the home country has incentive to invest abroad to
exploit lower manufacturing costs and to prevent the loss of the export market to local producers.
3. In the mature product stage, cost competition among all producers intensifies. As the industry
contracts and concentrates, the lowest-cost producer is the winner here. At this point, the home country
innovator of the once-new product begins to import from lower cost producers from abroad.
Monopolistic Advantage Theory
The monopolistic advantage theory suggests that the MNEs monopolistic advantages enable it to operate
its subsidiaries more profitably than domestic firms.
These advantages are specific to the investing firm, rather than to the location of its production.

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The International Trade

Monopolistic advantage is the benefit incurred to a firm that maintains a monopolistic power in the
market.
Two sources:
oSuperior knowledge this knowledge can come in the form of production technologies, industrial
organization, managerial skills and knowledge of product. These are all resources that
are more easily transferable across borders;
oEconomies of Scale such scale economies can occur through horizontal or vertical foreign direct
investment. Most especially for the large MNE, economies of scale arise from its ability to
perform activities differently and more efficiently at a larger scale or volume.
Horizontal FDI refers to investment in the same industry abroad as that in which the firm operates at
home. The increase in production through horizontal investment permits a reduction in cost services such
as financing, marketing, or technological research.
Vertical FDI refers to investment in associated industries in the same chain of vertical integration in
which each affiliate produces those parts of the final product for which local production costs are lower.
Internalization Theory
Internalization it the activity in which an MNE internalizes its globally dispersed foreign operations
through a unified governance structure and common ownership. The incentives to internalize activities are
to avoid disadvantages in external mechanisms of resource allocation or to benefit from an internally
integrated and intra-organizational network.

Internalization Advantages
Internalization advantages include the following:
1. Avoid search and negotiating costs. MNEs are able to source inputs internally through its own
subsidiaries, thereby avoiding the cost of having to search the external market for suppliers
and the cost of having to negotiate with suppliers;
2. Avoid costs of moral hazard. Moral hazard refers to hidden detrimental action by external partners
(i.e. suppliers, buyers, and joint venture partners) Moral hazards can occur because the MNE does not
have control over the actions and activities of its autonomous/independent partners;
3. Avoid cost of violated contracts and ensuing litigation. Another source of unpredictability is the
dependability of suppliers/partners.

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4. Capture economies of interdependent activities. As in the case of horizontal (lateral) integration, but
even more so with vertical backward and forward integration, MNEs are able to create greater intraorganizational efficiency with its various subsidiaries when they concentrate on the production of
particular products/product inputs in those subsidiaries that are best capable of producing these efficiently
and consequently capture economies of scale for those product/inputs;
5. Avoid government intervention (e.g. quotas, tariffs, price control). If an international MNE already owns
a host country based production/operation facility via acquisition or Greenfield investment, those entities
are no longer subject to the same tariff and non-tariff hurdles that an exporter/importer would
otherwise be subjected to
6. Control supplies and conditions of sale inputs. For instance, in market conditions where the external
market fails to provide products or services that are of the necessary quality, the MNE can gain much
through internally sourcing its resource needs.
7. Control market outlets. On the forward (downstream) vertical integration side towards the buyers end
of the value chain, firms can gain a lot by owning their own distribution facilities and not
having to rely on Export Management Companies.
The Eclectic Paradigm Theory
A general framework used for explaining international production is provided by the eclectic paradigm
theory. This paradigm recognizes the importance of the following variables (OLI framework):
1. Ownership-specific (O). For instance, a comparative advantage in a tangible assets such as
natural endowments, manpower, and capital, and intangible assets such as technology, information,
managerial, marketing, and entrepreneurial skills, and organizational systems.
2. Location-specific (L). These refer to the greater benefit that the firm derives from a foreign
establishment market structure, government policies, and the political-legal and cultural environments in
which FDI is undertaken.
3. Internalization (I). Internalization refers to the firms inherent flexibility and capacity to produce
and market through its own internal subsidiaries. The firm can derive greater benefit from exploiting a
foreign opportunity itself, rather than through agreement with a foreign firm over which it has no control.

This theory distinguishes between structural and transactional market

failure:

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1. Structural market failure is an external condition that gives rise to monopolistic advantages as a
result of entry barriers erected or increased by incumbent firms or governments.
2. Transactional market failure is the failure of intermediate product makers to transact goods and
services at lower cost than that incurred through internalization.
The following two are strengths of the Eclectic Paradigm Theory:
1. It combines and integrates country-specific, ownership specific, and internalization factors in
articulating the logic and benefits of international production.
2. Although the business environment and MNE behaviors differ markedly from two decades ago, the OLI
framework is still vital in explaining why FDI takes place and where MNEs superior returns come from.
Limitations of the Eclectic Paradigm Theory:
1. It does not address how an MNE owner-specific advantages like resources and capabilities should be
deployed and exploited in international production.
2. It does not delineate the ongoing, dynamic process of international production wherein FDI resource
commitment, production scale, and investment approaches change over time.
New Perspectives on FDI
The Dynamic Capability Perspective
Dynamic Capabilities refer to a firms ability to diffuse, deploy, utilize, and rebuild firm-specific
resources in order to sustain competitive advantage.
Dynamic Capability requires two things:
oCapability exploitation is the capacity to extract economic returns from current resources; and
oCapability building is the capacity to learn and develop new capabilities
Resource deployment is the first step in capability exploitation. This involves two kinds of resource
deployment:
oQuantity-based deployment refers to the amount of critical resources deployed in a target foreign
market;
oQuality-based resource deployment involves the distinctiveness of resources.
oTransferability is the extent to which MNE resources or knowledge developed at home can be
transferred to a foreign sub-unit to yield competitive advantage or contribute to success
in the target foreign setting. Among the more transferable
resources are:
oTechnological capabilities, e.g. design for manufacturing, time to market, patents and intellectual
property, low cost manufacturing;

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oFinancial capabilities, i.e. also known as financial solvency, this is the firms ability to manage
its money;
oCapital or cash flow management skills, e.g. the management of payables, receivables, and
inventory and the use of ratios and financial planning;
oInternational experience and global reputation. This is related to organizational learning
that shapes its adaptation and changes made to improve and conform to its environment.
less transferable resources are:
1. Organizational skills;
2. Operational capabilities;
3. Work-force related capabilities; and
4. Home country experience and reputation.
The Evolutionary Perspective
This perspective claims that international investment is an ongoing, evolutionary process shaped by and
MNEs international experience, organizational capabilities, strategic objectives, and environmental
dynamics.
Accumulated knowledge about country-specific markets, practices, and environments helps firms in the
following ways:
1. Reduces operational uncertainty. Uncertainty comes with lack of experience and the learning that
comes with an examination of those organizational experiences. With an increase in experience and
learning comes a decrease in uncertainty;
2. Increase local commitment. This is the natural and necessary outcomes of uncertainty reduction; and
3. Enhances economic efficiency. This is the ultimate end result of the continual learning, and adaptation
process of a firm seeking to continually improve itself and make it more competitive in its environment.
Internalization process involves the interplay between the development of knowledge about foreign
markets and operations on one hand, and an increasing commitment of resources on the other.
There are two kinds of knowledge distinguished in the model:
Objective knowledge which can be taught, e.g. steps on how to set up an in-house marketing firm;
Experiential knowledge which can only be acquired through personal experience, e.g. how local
culture will respond to and change the attitudes and corporate behavior of a first-time foreign market
entrant.
The internalization process model explains two patterns of internalization of the firm:
1. Firm progressively engages in target market. The particular stages in this pattern are as follows.

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o1st stage exports start to take place via independent representatives (trading companies)
o2nd stage sales subsidiaries are set up in the foreign market, specializing in marketing and promotion
o3rd stage manufacturing facilities are established overseas, involving activities such as R&D,
marketing, outsourcing, and reinvestment.
Integration-Responsiveness Perspective
The framework known as the integration (I) and local responsiveness (R) paradigm (or the I-R paradigm)
suggests that participants in global industries develop competitive postures across two dimensions.
These dimensions create two imperatives:
oGlobal integration refers to the coordination of activities across countries in efforts to build
efficient operation networks and maximize the advantage of similarities across locations.
oLocal responsiveness concerns response to specific host country needs.

MNEs choose to emphasize one dimension over another or compete in both directions. There are three
basic strategies:
oIntegrated strategy requires strong worldwide coordination; requires highest degree of
internalization
oMulti-focal strategy is the middle ground between integrated and locally-responsive strategies;
requires medium-level internalization and this can also apply to the organizations marketing activities
Strategic Flexibility View
This is more of an enrichment of the I-R paradigm by Bruce Kogut. This view is composed of two related
concepts:
1. Operational flexibility; and
2. Strategic options.
Kogut summarizes the five opportunities arising from strategic flexibility:
1. Production movement. This permits the firm to respond to shifts in market and cost factors, especially
the exchange rates;
2. Tax avoidance. An MNE can adjust its markup on intracompany sales of goods in order to realize
profits in low tax jurisdictions;
3. Financial arbitrage (or the profiting from the differences or yields in different markets, e.g. buying
stocks low in one market, then selling it high in another to gain profit). MNEs can circumvent host
government instituted restrictions on finance, remittance, and foreign exchange balance, with some
innovative financial products;

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4. Information transfer. MNEs that are flexible are able to benefit from identifying more opportunities,
scanning world markets to match buyers and sellers, and avoiding non-tariff and tariff barriers to trade;
5. Competitive power. This refers to the ability o MNEs to differentiate prices according to their world
competitive posture. For instance, different links in the value-added chain also provide leverage on
enforcing equity claims or contracts in national markets.

FDI Outflows
Currently, Developed countries account for most of FDI outflow. This is simply because MNEs from
developed countries are likely to possess the following advantages:
oOwnership or monopolistic advantages. This can easily arise in instances wherein the firm
possesses core competencies or resource capabilities that are unmatched by local players;
oMore likely to be innovators. Related to the Product Life-Cycle theory we studied earlier, innovating
MNEs can enjoy a temporary advantage over domestic players that do not possess the high capital
required for Research and Development of new products. In all likelihood, innovating firms developed
countries will enjoy market dominance in a certain product of service category, that is, until such time that
the knowledge required to imitate such products is diffused over the market;
oMore likely to be able to extract advantages from internalization. This eliminates a lot of potential
risks and costs such as possibility of contractual breach from suppliers and the costs of search and
negotiation for product inputs or labor; and
oMore likely to have dynamic capabilities for venturing abroad. These dynamic capabilities refer to
the firms ability to diffuse, deploy, utilize and re-build firm-specific resources in
order to sustain competitive advantage.

THE MNE AND SMIE

Definition of the MNE & Other International Firms
oInternationally committed company is a firm w/ at least one majority-owned plant or a joint
venture abroad but which lacks representation in all major regions of the world such as Asia,
Europe, and the Americas.
oInternationally leaning firm is one w/ foreign sales and possibly a representative office and/or
licensing agreement, but with no ownership of foreign production sites.
oMultidomestic firm is an enterprise w/ multiple international subsidiaries that are relatively
independent from headquarters.

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oGlobal firm consists of closely integrated international subsidiaries controlled and coordinated from
central headquarters.
Transnational firm consists of subsidiaries that fulfill varying roles with some subsidiaries playing a
strategic role that in the global firm is reserved for headquarters.
oMultinational firm or MNE is an enterprise that engages is FDI and owns or controls value-adding
activities in more than one country.
MNEs typically possess the following traits:
oHave multiple facilities around the globe.
oDerives a substantial portion of revenues from foreign operations.
oRuns subsidiaries with a common strategic vision and draw from a common pool of resources. This is
related to internalization.
oPlaces foreign nationals or expatriates at the board level and/or in senior management posts.
Degree of Internationalization
The level of MNE internationalization is gauged by the transnationality index (TNI). This index is
calculated as the average of three ratios:
1. Foreign assets total assets
2. Foreign sales to total sales
3. Foreign employment to total employment
The Competitive Advantage of MNE
MNE Capabilities
As previously discussed in the dynamic capability theory, an MNE must not merely rely on already existing
resources, it must develop dynamic capabilities to create, deploy, and upgrade resources, in pursuit of
competitive advantage.
MNE Capabilities. Domestic firms often enjoy an advantage over MNEs in terms of familiarity with a)
a) National culture. It is often argued that business practices are an offshoot of national culture.
b) Industrial culture. This refers to the knowledge, beliefs, and values associated with production.
Production system refers to a manufacturing philosophy where production is dependent on a balanced
integration between human skills, collaborative work organization, and adapted technology; Government
requirements.
MNEs must have strategic and organizational capabilities such as listed
below to mitigate such disadvantages as compared to domestic firms:

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oStrategic capabilities. These include technological assets such as patents, trade secrets,
proprietary designs, product development and process innovation.
oManagerial skills come in the form of global human resource management, information,
organization design, and control systems.
oInternational experience (also referring to the evolutionary view) is essential to strategic and
organizational capabilities.
Capability Deployment involves the MNEs ability to transfer critical capabilities that are unavailable
to local players.
Capability Building/Upgrading is the firms capacity to learn and gain more from experience and
apply it to other relevant situations.
Learning capability is the capacity to generate ideas and acquire new knowledge.
The firm must convert it into firm specific resources.
This involves the following;
1. Acquisition of knowledge (be it through internal development or external learning.
2. Sharing. This simply refers to the transfer of relevant information among the units of the MNE; and
3. Utilization. Bridging the new knowledge towards the implementation of changes made necessary as a
consequence of that new learning. Firms cannot utilize newfound knowledge if it does not possess the
proper organizational mechanism to transfer information, promote learning, or implement changes.
Obstacles Facing DMNEs
DMNEs face a number of challenges/ obstacles in entering foreign markets. These include the following:
1. Resource Constraints DMNEs often cannot afford huge capital investments unlike MNEs from
developed nations. Lack of reputation and brand recognition are also obstacles faced by
DMNEs,
2. Lack of Knowledge DMNEs often lack experience in foreign operations; many do not possess
production, marketing, and management skills. This is related to the evolutionary perspective that
stresses the importance of experiential knowledge that comes only through firsthand dealings with
foreign markets.
3. Sheltered Environment many DMNEs enjoyed monopolistic advantages, cost advantages or
protectionist measures in their domestic markets for a long time.
DMNE Advantage in Global Markets
DMNEs can develop some unique advantages that position them well in the competition established by
MNEs.
The two main sources of DMNE advantage are:
1. Home Government Support DMNEs enjoy the backing of their home government to an extent
that they may compensate for ownership and location disadvantages;

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2. Flexibility the lower production scale of DMNEs permits flexibility and adaptation critical in
international markets.
Typical Features of DMNEs
Some of the motivations of DMNEs are similar to those of MNEs from developed economies. The
Internationalization patterns of DMNEs are like those of MNEs in the following ways:
1. Exploit firm-specific or owner-specific advantages. These refer to the competitive advantages of
the firm that other cannot easily copy such as technological knowledge;
2. Overcome tariff and non-tariff barriers to exports. In many ways, these tariff and non-tariff barriers
pose an even greater challenge to DMNEs who dont have the same power as an MNE in getting
governments to acquiesce to its requests;
3. Obtain low-cost production bases. This is always a strong driving force and search parameter for a
new investment location decision;
4. Escape stringent environmental limitations. in the lowest common denominator argument of
environmentalists, even DMNEs may want to seek countries with less strict environment regulations as it
will usually mean that the avoidance of such stringent regulations will mean less cost outlay.

DMNEs also have a number of unique reasons to pursue foreign trade and investment. They are:
oTo develop ownership advantages. While MNEs move abroad to exploit already existing
advantages, DMNEs move out to develop such advantages;
oTo serve as intermediaries. DMNEs rely on technologies from industrialized nations to develop
products they can in turn export,
oTo overcome import quotas in developed markets. By locating FDI in a developed market that
has an existing trade agreement w/ home country.
Other typical features of DMNEs are as follows:
oFocus on other developing markets DMNEs are likely to have a greater share of FDI in
other developing markets where the combination of intermediary technology and low-cost provide a
competitive advantage.
oReliance on third parties DMNEs tend to rely heavily on other entities to compensate for their
resource shortage. For instance, Acer relies on component parts manufactures in SBUs located in other
developing economies.
oGovernance DMNEs are less likely to be publicly traded and are often tightly controlled by a
founding family or government.
oIndustry Domain DMNEs are more likely to be in manufacturing, starting with labor-intensive
production and gradually moving into technological and market-intensive products based on imported
technology.

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oBargaining Power DMNEs lack bargaining power in the host country and cannot offer much by
way of assisting in pressuring host governments. This is one of the pitfalls of being a relatively small
player unlike MNEs that can lobby the government to acquiesce to its demands;
oStrategy DMNEs are more likely to compete on the basis of price than product differentiation. This
is because product differentiation often entails investment in research and development.

Six Strategies DMNEs Can Pursue

The following are six strategies that DMNEs can pursue:
1. Low-cost commodity, where a firm competes on price and exports out of its home base,
2. Manufacture for private label, where a company manufactures a product but sells it under the
retailers brand name.
3. Component manufacturing, where a company manufactures inputs to be assembled and
marketed by the MNE.
4. Low-cost leader, where the DMNE sells an assembled product but competes mostly on cost.
5. First-generation/market-specific technology, where a DMNE focuses on a market similar
to its own,
6. Specialized niche, whether in a given country, or region, or worldwide.
Obstacles to SMIE Internationalization
Some of the main obstacles of the internationalizing SME are as follows:
a) Scale and Transaction Constraints, e.g. the small scale and limited reach of the SMIE limit its
production and service delivery options and costs;
b) Access to Capital, e.g. the shortage of capital has correlates such as inability to obtain reliable
market information and training for its traders;
c) Lack of Knowledge, e.g. SMIEs usually do not possess relevant knowledge about how to conduct
market research or address foreign currency fluctuations;
d) Lack of Market Power, e.g. SMIEs are too small to bargain with local governments and cannot
produce the large quantities that would trigger local suppliers to manufacture to their specs;
e) Vulnerability to Intellectual Property Violations, e.g. SMIEs lack the resources to pursue
violators across the globe. The same is true for the uniform application of product standards.
SMIE Advantages in Internationalization
The following are distinct advantages of the SMIE on which their success in the global marketplace are
dependent:

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1. Innovativeness. This simply means the ability to generate ideas or inventions that can translate
into a good or service for which people will pay;
2) Creativity. This refers to the mental characteristic of an organization that allows it to think outside of
the box, which later results in innovative or different approaches to a particular task;
3) Entrepreneurial spirit. This refers to the capacity and willingness to undertake conception,
organization, and management of a productive venture with all attendant risks while seeking profit as a
reward;
4) Lower overhead cost. SMIEs are normally less invested in capital intensive assets and thus do
not have the same amount of sunk costs incurred as MNEs;
5) The ability to move fast to take advantage of opportunities (flexibility in
adaptation). the ability to alter an organizations actions to correspond to external market conditions in
a manner that ensures organizational survival and profit while decreasing attachment to assets already in
place;
6) The ability to leapfrog technologically. Viewed as a theory of innovation, this involves the
capacity of SMIEs to adapt and innovate on the original technologies of MNEs that may have lost
incentive to
continue innovation.

SMIE Internationalization Features

An UNCTAD survey identified a number of drivers for SME internationalization. They are as follows:
a) Push factors. These are competitive pressures in the domestic market that push the SME to
pursue certain objectives in the international market like low-cost alternatives to decrease labor costs,
increase market share through foreign investment, or increase scale to benefit from economies of scale ;
b) Pull factors are the traits that make foreign markets attractive like rapidly expanding markets, growth
potential, or lower production costs;
c) Management factors include managerial commitment and resources devoted to international
activity;
d) Chance factors are unforeseen circumstances that open up opportunity for internationalization.

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The following are distinct traits of FDI pursued by SMIEs:

1) Emphasis on Developed Markets. SMIEs are more likely to invest in developed rather than
developing markets. Host country red tape, economic instability, etc. are among the reasons that SMIEs
avoid
developing markets and since these SMIEs do not have the same amount of negotiating or bargaining
power as MNEs, they choose to avoid these difficult to enter markets altogether.
2) Selective Globalization. SMIEs tend to focus on one link in the supply chain as well as on a
selected market.
3) Strategy. SMIEs often adopt niche strategies, pursuing areas not covered by large firms due to
neglect, lack of expertise, high cost structure, etc.

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