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FDI & Trade – Articles
Article 1 : Krugman, P. (2001) Competitiveness: A Dangerous Obsession
The idea that a country’s economic fortunes are determined by its success on the world markets is a
hypothesis, not necessarily a truth. It is simply not the case that the world’s leading nations are to
any important degree in economic competition with each other, or that any of their major economic
problems can be attributed to failures to compete on world markets. As such, the obsession with
international competitiveness should be seen as a view held in the face of overwhelming contrary
evidence. The main points of this article are that concerns about competitiveness are unfounded, it
tries to explain why international competition is so attractive, and it argues that the obsession is not
only wrong, but also dangerous, skewing domestic policies and threatening the economic system.
Corporation can go bankrupt, though countries cannot. This difference alone renders the concept of
national competitiveness elusive. A trade balance cannot be seen as a measure of competitiveness.
Competitiveness is our ability to produce goods and services that meet the test of international
competition while our citizens enjoy a standard of living that is both rising and sustainable. However,
when a country rarely trade, the level of competitiveness would be determined by domestic factors,
so competitiveness would just be another word for productivity.
The major industrial countries are also each other’s main export markets and each other’s main
suppliers of useful imports. If the European economy does well, it need not be at US expense, but if
anything is more likely to help the US economy by providing it with larger markets and selling it
goods of superior quality at lower prices. International trade is not a zero-sum game.
Many, many authors who hold the view that countries should be competitive, messed up their
numbers big time.
The rhetoric of competitiveness has become so widespread for three reasons. First, competitive
images are exiting, and thrills sell tickets. Second, the idea that US economic difficulties hinge
crucially on our failures in international competition somewhat paradoxically makes those difficulties
seem easier to solve. Finally, many world leaders found the competitive metaphor extremely useful
as a political device.
Thinking and speaking in terms of competitiveness poses three dangers. First, it could result in the
wasteful spending of government money supposedly to enhance competitiveness. Second, it could
lead to protectionism and trade wards. Finally, it could result in bad public policy on a spectrum of
important issues.
Article 2 – Baldwin, R. (2006) Globalisation: the great unbundlings
The cost of moving goods, people and ideas, has tended to result in the geographic clustering of
production and people. Rapidly falling transportation costs cause the first unbundling, namely the
end of the necessity of making goods close to the point of consumption. More recently, rapidly falling
communication and coordination costs have fostered a second unbundling – the end of the need to
perform most manufacturing stages near each other. The second unbundling has spread from
factories to offices with the result being the offshoring of service-sector jobs. In a nutshell, the first
unbundling allowed the spatial separation of factories and consumers, and the second unbundling
spatially unpacked the factories and offices themselves (fragmentation, offshoring, vertical
specialization, slicing up the value chain).
Before the second unbundling, firms and sectors were the finest level at which globalization’s impact
was felt. Now, global competition occurs on a task-by-task basis.
The first unbundling has been marked by six features, being industrialization/deindustralizion
(North/South), international divergence/convergence (North/South), trade, growth take-off
(industrial revolution), urbanization, and internal divergence. There are several economic forces that
account for the six stylized facts:
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Agglomeration’s hump-shape. (market size and agglomeration forces feed on each other
(circular causality)). At intermediate levels of trade-cost, agglomeration forces are strongest.
Home market magnification effect. Lower trade costs make industry more footloose, not
less. This effect is known as the Home Market Magnification effect.
Growth take off. As the transport cost of goods fell with the development of inland water
transport and eventually railroads, industry and thus industrial innovation and learning
became geographically concentrated, resulting in innovation and specialization which gave
the North a cost-advantage over the south, leading to a massive income gap.
In the second unbundling, geographically separating various production stages became more
attractive as the north-south productivity-adjusted wage gap grew, and separation became less
costly with cheaper telecommunications and air shipping. In services, tasks that were previously
viewed as non-traded became freely traded when telecommunication costs drop to almost zero.
Insight #1: Production unbundling as technical progress: trade in intermediate goods and services
that were previously packaged together in a black-box production function.
Insight 2#: Terms of trade effect (some tasks can be done by low wage workers, average price will
fall), jobs effect (demand for domestic workers will fall, so wage falls), and the productivity effect
(rise in average productivity, rise in wage).
Insight 3# Samuelson’s caveat: Strange, never mind.
Tasks that can be provided at a distance are likely to be offshored, but the list of these tasks is
unlikely to line up with education attainment or at least not as neatly as it has in the past. Offshoreable jobs are those characterized by IT intensity, output that is IT transmittable, tasks that are codefiable, and little face-to-face interaction.
Article 3 – Sourdin, P. & Pomfred, R. (2012) Measuring International Trade Costs
The size of trade costs matters for trade negotiations and for empirical research on international
trade. A general measure of trade cost is the difference between the value of traded goods at the
point of export and their value after they clear customs in the importing country, excluding import
duties (fob/cif). However, there is no perfect measure of trade costs because there is no agreed
definition of trade costs. The foc-cif measure is limited by data availability and captures only the
financial side of trade cost, not the times costs of international trade, which are critical for perishable
goods. However, when there are large numbers of transactions, the cif-fob data provide a useful
estimate of actual trade costs.
Poor institutions increase trade cost, but the pattern of increases is commodity specific and the
results are stronger for air transport, which is consistent with the hypothesis that time-sensitive
goods are more responsive to trade-costs.
The conclusion states that trade costs have become a central concern in international trade theory
and policy. The current best measure of aggregate trade costs is the cif-fob gap proposed by
Hummels. This has conceptual problems associated with defining trade costs and ignoring time costs,
but the main drawback is empirical, as mirror data are too flawed to be useful, and consistent cif-fob
data are only available from a handful of exporters. The cif-fob gap is an imperfect guide to the
degree to which policy facilitates trade, because countries may have higher measured trade costs
because of exogenous factors such as being landlocked or lacking a deep-water harbor or their
comparative advantage may lie in bulky high-transport-cost goods. Yet, the cif-fob gap measure is
superior both conceptually and operationally to any other current measure of actual trade costs.
Article 4 – Rose, K. (2004) Do we really know that the WTO increases trade?
It turns out that membership in the GATT/WTO is not associated with enhanced trade, though the
WTO states that its overriding objective is to help trade flow smoothly, freely, fairly, and predictably.
In testing the influence of the WTO, Rose relies on the standard gravity model of bilateral trade,
joined by the variables culture, geography, and history.
The gravity model checks for all kinds of normal variables that could explain the level of trade
between two countries, such as the real gdp, currency value, population, distance, et. and also
includes membership in the WTO.
The gravity model works well. Countries that are farther apart trade less, while economically larger
and richer countries trade more. Countries belonging to the same regional trade association trade
more, as do countries sharing a language, or land border. Landlocked countries trade less, as do
physically larger countries. A shared colonial history encourages trade. Even the notorious currency
union effect has an economically and statistically significant effect. These variables explain two-third
of the variations in bilateral trade.
Rose is unable to find evidence that membership in the GATT/WTO has had a strong positive effect
on international trade. However, there is clear significant variation in the coefficient across trade
rounds, in which the first two round do show economically large effects on trade (insignificant?).
When not taking distance and output into account, WTO membership shows that a pair of members
share 345% the level of trade of a pair of nonmembers. However, simply taking into account
standard gravity effects essentially eradicates any large effect of the GATT/WTO on bilateral trade.
Why have trade grown fast than income, if not because of the GATT/WTO? Possible candidates are
the higher rates of productivity in tradables, falling transport costs, regional trade associations,
conversing tastes, shift from primary products towards manufacturing and services, growing
international liquidity, and changing endownment.
Article 5 Bernard et al. (2007) – Firms in International trade
Of the 5.5 million firms operating in the US, only 4 % were exporters. However, trading firms differ
substantially from firms that solely serve the domestic market. Exporters, have been shown to be
larger, more productive, more skill- and capital-intensive (even in emerging economies, not
according to factor abundance theory), and to pay higher wages than non-trading firms. These
differences exist even before exporting begins. Exporters are more productive, not as a result of
exporting, but because only the most productive firms are able to overcome the (sunk) costs of
entering export markets. When trade policy barriers fall or transportation costs decline, highproductivity exporting firms survive and grow, while non-exporting firms are more likely to fail.
A large share of international trade takes place between relatively similar trading partners within
industries. A combination of economies of scale and consumer preferences for variety lead otherwise
identical firms to specialize in distinct horizontal varieties, spurring two-way or intra-industry trade
between countries.
Exporting is more likely and export intensity is higher in more skill-intensive sectors than in more
labor-intensive sectors.
Aggregate productivity growth is obtained, driven by the contraction and exit of low-productivity
firms and the expansion and entry into export markets of high-productivity firms. This reallocation of
resources from low- to high-productivity establishments raises average industry productivity.
The extensive margin is the number of products that a firm trades and their number of export
destinations, whereas the intensive margin concerns the value they trade per product per country.
Both the number of exporting firms and the number of exported products are sharply decreasing in
the distance of the destination country (extensive margin) and increasing in importer income. In
contrast, the average export value (intensive margin) is increasing in distance and decreasing in
importer income.
Article 6 – Bernard et al. (2011) The empirics of firm heterogeneity and international trade.
Higher variable trade costs reduce the value of exports of a given exporter, which reduces average
firm exports. On the other hand, higher variable trade costs imply that some exporters who were
previously close to the productivity threshold for exporting can no longer generate sufficient variable
profits to cover the fixed costs of exporting and exit the market. Since these exiting exporters have
smaller export values than surviving exporters, this raises average firm exports through a change in
composition.
An implication of the Melitz model is that the extensive margin of the number of exporting firms
should vary systematically with export market size, since in larger markets firms of lower productivity
can generate sufficient variable profits to cover the fixed costs of exporting.
The 12 percent of firms that export more than five products to more than five destinations account
for more than 90 percent of export value.
Most export companies also import. Import tariffs may affect productivity through a number of
potential channels, including learning about foreign technologies, expansion in the variety of
intermediate inputs available for production, and access to higher-quality intermediate inputs.
Aggregate economic relationships such as the gravity equation are largely driven by the extensive
margins of firms and products rather than the intensive margin of average exports per firm-product.
Reduction in trade costs induce endogenous changes in internal firm organization as firms adjust
their range of products, their decisions about whether to serve foreign markets through trade or
overseas production, and their choices about whether to organize foreign production within or
beyond the boundaries of the firm.
Article 7 – Kenemy, T. & Rigby, D. (2011) Trading away what kind of jobs? Globalization, trade and
tasks in the US economy.
Many scholars believe that offshoring will replace physical and intellectual tasks that can easily be
routinized and rendered in blueprints. For others, the key distinction between tradable and
nontradable task is the related idea of interpersonal interaction. We know that the task structure of
work in many advanced, industrialized economies has made a pronounced shift toward nonroutine
interactive and analytical activity, and away from routine cognitive and manual labour.
The purpose of this paper is to determine whether rising import competition from developing
countries is associated with changes in the task structure of the US economy.
The result show that import competition from less developed economies is associated with sectorspecific increases in the demand for nonroutine task. The direction of the relationship between trade
and task structure resembles that of technological change, in keeping with theoretical expectations.
Computer investment in manufacturing, the proxy for skill-biased technology change, has no
significant relationship with nonroutine task shares. Furthermore, imports from developing countries
are positively and significantly related to the growth of interpersonal and analytical tasks through the
US economy.
As a result of factor-prize equalization, high skilled workers in advanced economies gain from trade,
while their low-skill colleagues lose. The reverse should be true in developing economies.
Most scholars argue that the increased penetration of computers and other technologies into the
economy has raised the productivity and wages of workers with high levels of human capital, while
having little impact on the wages of less-skilled workers.
Tasks that demand significant interpersonal interaction or complex problem solving, together
referred to as nonroutine cognitive tasks, are considered to be place bound, while tradable tasks are
those characterized by routing, codifiable work conducted through stable and predictable markets.
Labour economist have already shown that the task structure of several advanced economies has
shifted from an emphasis on routine to nonroutine tasks. This is confirmed by the descriptive results
of this article.
Industry shipments and capital intensity are positively related to the nonroutine share of tasks in US
manufacturing, where there is no significant relationship between computer investment and the
relative demand for nonroutine tasks in this model. Most variation in the dependent variable is
related to between-industry differences in the relative demand for nonroutine tasks. Results show
that the nonroutine share of tasks in US manufacturing is positively and significantly related to
import competition from less developed economies, to shipments and to capital intensity. Import
competition from low wage developing economies is significantly and positively associated with
greater relative demand for nonroutine interactive and analytic tasks. Finally, the share of routine
manual tasks is negatively related to industry output.
Article 8 – Marin, D. & Rousova, L. (2011) The organization of European Multinationals
The ability of a multinational firm to transplant its home productivity advantage to other countries is
by no means secure. This paper investigates the factors that determine whether multinationals
export their business model to the countries they invest in.
As a measure of internal organization of parent and subsidiary firms, the authors use the level of
decentralization of thirteen corporate decisions, while checking whether business cultures are
transported the organization or though the CEO.
It appears that decentralized parent firms transplant their organization significantly more often than
centralized parent firms. Centralized parent firms tend to have significantly more centralized
subsidiaries and decentralized parents have more decentralized subsidiaries. Subsidiary firms are
more decentralized when their parent firms are more decentralized, when parent firms themselves
are a subsidiary of a domestic multinational and when parent firms have more affiliates in other
countries. Subsidiaries will be more centralized when their parentfirms are larger or when they are a
subsidiary of a foreign multinational. In addition, subsidiaries tend to be more decentralized when
they are a horizontal foreign investment and more centralized when they are more tightly linked to
the parent firm.
The level of decentralization of subsidiaries declines with many domestic competitors. Moreover,
subsidiaries centralize their organization in response to a great exposure to international trade.
However, with many world competitors, decentralization increase.
More competition in parent firms market is estimated to significantly increase the level of
decentralization. Furthermore, improvement in the institutional quality of a country also leads to
more autonomy of the subsidiary.
The research shows that the most centralized and the most decentralized corporate decision tend to
be transplanted most often to foreign affiliates.
Multinationals are more likely to transplant their business model to foreign affiliates in host
countries when parent firms are more decentralized, the affiliates are larger and when multinationals
have larger number of affiliates. They are less likely to transplant when the affiliates are more
decentralized and further away, when the parent firm is itself a subsidiary and when it has a larger
stake in the subsidiary. Technology transfer increases the probability of transplantation.
Parents are more likely to send their own managers to run the affiliate firm when the parent and
subsidiary firm is larger, when the subsidiary firm is centralized and has little autonomy, when the
multinational firm does not have too many affiliates and when the technology transferred to the
foreign affiliate is innovative.
So tougher domestic and foreign competition in the subsidiary market favors transplantation via
organization but hinders transplantation via manager. Tougher domestic competition in the parent
market favors both types of transplantation, whereas foreign competition in the parent market
decreases the likelihood that mnes transplant at all.
Article 9 – Greenaway et al. (2012) The effect of exchange rates on firm exports and the role of FDI.
This paper investigates the responses to exchange rate fluctuation and how these differ to MNEs
from different origins. MNEs have greater scope to deal with exchange rate fluctuations, such as
hedging in forward markets, leading and lagging payable and receivables, and diversification across
export markets. However, MNEs cannot quickly adjust factor inputs to optimally take account of any
price change.
The authors expect that MNEs from outside of the EU are likely to choose the UK for export platform
FDI motive, whereas for those acquisitions by MNEs already inside the EU, horizontal motives are
likely to be stronger.
Movements of exchange rate levels have little effect on export participation firms decisions but do
have a significant and negative impact on export intensity after entry, so they effect the intensive,
but not the extensive margin.
Size and labour productivity are positively associated with export participation, whereas the effect of
wage and age are positive but insignificant. Foreign owned firms are more likely to export than
domestic firms, even when conditioning on relatively better performance characteristics. Finally, the
authors find that the lagged export status of the firm has a strong and significant impact on export
status. Exchange rates have no effect on firms decision to export. Firms with higher level of real
wager are associated with higher rations of exports to total sales. Younger firms are more export
intensive, as are foreign owned firms. The real exchange rate have a significant effect on firms export
share decisions. The evidence suggests a larger negative exchange rate impact on the export shares
of UK firms compared with other studies. EU multinationals are already close to centres of demand
and therefore have an incentive to use the cost advantage offered by exchange rate fluctuations to
change the production decision across their affiliates within the EU. Firms from outside the EU
behave similarly to domestic firms, but different from EU multinational firms. EU multinational firms
respond more strongly to exchange rate changes than domestic and non-eu multinationals.
In conclusion, results show that firm export participation decisions are not strongly related to
exchange rate movements. The exchange rate however has a significant and negative impact on the
export share of firms after entry. Multinationals originating from countries outside the EU are less
affected by changes in the exchange rate compared to those inside it, which appear similarly affected
as domestic firms. Finally, firms from other EU countries have an advantage in being able to shift
production decisions across its plants to exploit competitiveness advantages following exchange rate
changes.
Article 10 – Marin, D. & Rousova, L. (2011) Who is afraid of political risk? Multinational firms and
their choice of capital structure.
MNEs have to adapt their optimal investment strategy to local conditions worldwide., including
varying political risks. This risk ranges from outright expropriation to more subtle forms like
confiscatory taxation. This paper investigates the way MNEs choose their capital structure in
response to political risk by focusing on two choice variables, being the level of leverage and the
ownership structure of the foreign affiliate. Choosing higher leverage reduces tax payments but
increases the risk of bankruptcy, involving some bankruptcy costs. Furthermore, he chooses how
much of the affiliate to sell to outside investors, taking into account how that affects the agency
costs and the value of the affiliate.
There are three types of political risk: outright expropriation or nationalization(I), expropriation
(II)(e.g., loss of intellectual property rights), and discriminatory and confiscatory taxation.(III)
The optimal debt level decreases with increasing political risk in both I and II, because expropriation
increases the risk of bankruptcy, which calls for smaller leverage. The optimal debt level increases
with political risk in III because the negative effects can be contained with higher leverage. In all
three scenarios, the optimal ownership share tends to decrease as the level of risk increases, because
the investor’s return is reduced, but the managerial costs remains the same. The ownership share
reduction is less pronounced in III, where the debt level increases, as compared to the cases of
expropriation, where the debt level is reduced as a response to political risk.
MNEs hold a smaller share of equity when political risk is high and use a higher level of debt in
countries with a higher level of political risk.
Larger ownership stakes are associated with higher firm values, because they allow for a better
alignment of the incentives of owner and manager or inside and outside investors.
The optimal debt level increases as the local tax rate increase. Moreover, the optimal ownership
share decreases as tax increases. Both the optimal debt level and the optimal ownership shares
decrease as (creeping) expropriation increases. The optimal debt level increases as confiscatory
taxation increases. The optimal ownership share reacts more negatively to expropriation than to
confiscatory taxation.
Why does it matter how political risk affects the multinational choice of capital structure? Smaller
ownership shares may negatively affect the governance structure of the MNE because the lead to
small incentives for controlling the firm effectively. In addition, this can reduce the investor’s
incentive to transfer necessary technology. Higher leverage lead to higher dead weight losses arising
from inefficient bankruptcy procedures and add to the social cost of political risk.
Article 11 – Barrios et al. (2009) International taxation and multinational firm location decisions.
Host-country and parent-country corporate income taxation both discourage the location of foreign
subsidiaries in a particular country. Corporate taxation of foreign-source income is important in
shaping the organizational structure of multinational firms. Moreover, tax sensitivity of location
increase with the number or countries of location and in fact peaks for intermediate numbers of
countries of location. Finally, host-country average effective tax rates are important in determining
foreign location choice, even if taxation does not appear to affect the earlier choice to locate abroad
or export.
The main result is that parent-country (double) corporate taxation has an independent strongly
negative effect on the probability of foreign subsidiary location in potential host countries, despite
the fact that parent country taxation can generally be deferred until income is repatriated. Location
decision regarding the parent firm are similarly shown to be affected by parent-country taxation, as
they are less likely to be located in countries with relatively high foreign-source income.
Estimated tax sensitivities of location decisions vary with the number of countries considered as well
as with the number of a multinational’s subsidiaries. Tax sensitivities are largest for multinationals
that invest in an intermediate number of countries.
Overall, the results show that parent-country taxation is instrumental in shaping the structure of
multinational enterprises.
Article 12 – Dharmapala, D. & Hines, J.R. (2009) Which Countries Become Tax Havens?
Tax havens are locations with very low tax rates and other attributes designed to appeal to foreign
investors. In general, tax havens are small countries, commonly below one million in population, and
are generally more affluent than other countries. Tax havens score very well on cross-country indices
of governance quality. Improving the quality of governance increases the likelihood of a small
country being a tax haven.
Countries want to become tax havens to attract foreign investment (elasticity of -0.6) Since they gain
a lot of money through for example personal income taxes or value added taxes, the reduction in tax
income is offset.
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