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IB test 2
Terms in this set (114)
Two main forms of FDI
1) Greenfield Investment - establishing a new operation in a foreign country
2) Acquiring or merging with existing firm in other country
Stock of FDI vs. Flow of FDI
Stock of FDI = total accumulated value of foreign-owned assets at a given time.
Flow = The amount of FDI undertaken over a given period of time (normally a year)
Executives see FDI as a way of ________
Overcoming future trade barriers
Much of the increase in FDI has been driven by the ____ and _____ that have been occurring in many of the worlds developing nations.
Much of the increase in FDI has been driven by the political and economic changes that have been occurring in many of the worlds developing nations.
The general shift toward ____ and _____ has encouraged FDI.
The general shift towards democratic political institutions and free market economies has encouraged FDI.
Gross Fixed Capital Formation
Summarizes the total amount of capital invested in factories, stores, and office buildings.
These countries dominate as the world's largest multinationals =
United Kingdom, France, Germany, Netherlands, and Japan.
The data suggest that the majority of cross-border investments are in the form of _______ and ______
The data suggests that the majority of cross-border investments are in the form of mergers and acquisitions.
Why acquisitions or mergers vs greenfield investments?
2) Firms have strategic assets, customer relations, trademarks/patents, distribution systems.
3) Firms believe that they can increase efficiency of the acquired unit by transferring capital, technology, or management skills.
Producing goods at home and then shipping them to the receiving country for sale.
Argument that combining location-specific assets or resource endowments and the firm's own unique assets often requires FDI. It requires the firm to establish production facilities where those foreign assets or resources endowments are located.
Granting a foreign entity the license or right to produce and sell the firm's product in fret urn for a royalty fee on every unit sold.
Claim firms prefer FDI over licensing to retain control over know-how, manufacturing, marketing and strategy.
Internalization theory 3 major drawbacks
1) Licensing may result in a firm's giving away valuable technological know-how to potential competitor.
2) Licensing does not give a firm the tight control over manufacturing, marketing and strategy in a foreign country that may be required to maximize its profitability.
3) Such capabilities are not amendable to licensing (firm's competitive advantage is based not as much on its products as on the management, marketing and manufacturing capabilities to produce those things.
Toyota is credited for _______.
Toyota is credited for lean production.
Who looked at the relationship between FDI and rivalry in oligopolistic industries?
Industry composed of a limited number of large firms (e.g. and industry in which four firms control 80 percent of a domestic))
When two or more enterprises encounter each other in different regional markets, national markets or industries.
Who developed product lifecycle theory?
Raymond Vernon's product lifecycle theory argued that often the same firms that pioneer a product in their home markets undertake FDI to produce a product for consumption in feign markets.
The eclectic paradigm was championed by ______?
John Dunning. Argued that location-specific advantages are also of considerable importance in explaining both the rationale for and the direction of FDI.
Advantages that arise from utilizing resource endowments or assets that are tied to a particular foreign location and that a firm finds valuable to combine with its own unique asset. Ex. Silicon Valley with technology
Balance of payments
National accounts that track both payments to and receipts from other countries.
Tracks the export and import of goods and services.
Current account deficit or trade deficit
Arises when a country is importing more goods and services than it is exporting.
The only way in which a current account deficit can be supported in the long run....
When selling assets to foreigners.
What are the 3 costs of FDI that concern host countries?
1) Adverse Effects on Competition
2) Adverse Effects on the Balance of Payments
3) National Sovereignty and Autonomy
FDI undertaken to serve the home market
In 2004, inward FDI accounted for some 24% of the gross fixed capital formation in Ireland, but only .6% in Japan. What do you think explains the difference in FDI inflows into the two countries?
One approach to this question is to look at government policy: Ireland is FDI-friendly and Japan has discouraged inward FDI. Both are trade-dependent economies with few natural resources, but Ireland appears far less mercantilist in attitude than does Japan. Ireland has a well-educated, relatively low cost workforce and an abundant supply of labor, while Japan's workforce, also well-educated, is expensive.
Compare and contrast these explanations of FDI: internalization theory, Vernon's product life cycle theory, and Knickerbocker's theory of FDI. Which theory do you think offers the best explanation of the historical pattern of FDI? Why?
Knickerbocker's theory suggests that firms imitate other firms in oligopolistic industries, and will "follow the leader" in undertaking FDI in certain countries, as sort of strategic defensive moves. This theory does not explain why the first firm undertakes FDI, and why it chooses to do this rather than to export or license. The product life cycle theory suggests that firms invest in foreign countries when demand in that country will support local production or when cost pressures make it necessary to locate production in low cost locations. While this theory does explain why some FDI takes place, it also does not explain why FDI is preferred over licensing or exporting. The market imperfections explanation more directly confronts these issues, and explains why FDI may be preferable to other alternatives for expanding business activities. It identifies the importance and difficulty of transferring know-how and describes some of the impediments to exporting. By explaining better exactly why a firm may undertake FDI, the market imperfections model is probably the best explanation of the historical pattern of horizontal FDI.
North American Free Trade Agreement 1994
• Currently North American, Canada, Mexico are apart of the North American Free Trade Agreement
Regional Economic Integration
Agreements among countries in a geographic region to reduce, and ultimately remove tariff and non tariff barriers to the free flow of goods and services and factors of production between each other.
In 1991 Argentina, Brazil, Paraguay, and Uruguay implemented an agreement known as a _______ to start reducing trade barriers between each other.
Free Trade Area
All barriers to the trade of goods and services among member countries are removed. No discriminatory tariffs, quotas, subsidies or administrative impediments are allowed to distort trade between members, but they are allowed to determine their own trade policies with nonmembers.
European Free Trade Association
Free trade association including Norway, Iceland, Liechtenstein, and Switzerland.
levels of Economic Integration
1) Free Trade Area
2) Customs Union
3) Common Market
4) Economic Union
5) Political Union
A group of countries committed to (1) removing all barriers to the free flow of goods and services between each other (2) the pursuit of a common external trade policy
A group of countries committed to (1) removing all barriers to the free flow of goods, services and factors of production between each other and (2) The pursuit of a common external trade policy.
A group of countries committed to (1) removing all barriers to the free flow of goods, services, and factors of production ; (2) the adoption of a common currency ; (3) the harmonization of tax rates and (4) the pursuit of a common external trade policy
The EU is a _______
The European Union (EU) is a economic union
Central political apparatus coordinates the economic, social and foreign policy of the member states.
Occurs when high-cost domestic producers are replaced by low-cost producers within the free trade area.
occurs when lower-cost external suppliers are replaced by higher-cost suppliers within the free trade area.
The European Union is the product of two political factors
(1) The devastation of Western Europe during two world wars and the desire for lasting peace
(2) The European nations' desire to hold their own on the world's political and economic stage.
Treaty of Rome
1957 treaty that established the EuropeanCommunity
Body responsible for proposing the EU legislation, implementing and monitoring.
The four main political structures in the EU
European Commission, the Council of the European Union, the European Parliament and the Court of Justice.
The European Council
Ultimate Controlling authority with the EU.
The purpose of the Single European act was ......
to have one market in place by December 31, 1992
Drawback of the euro
The EU is not what economists would call an optimal currency area.
Turkey has been denied by the EU because of.....?
Turkey has been denied by the European Union because of Human Rights issues.
Asia-Pacific Economic Cooperation (APEC)
Made up of 21 member states whose goal is to increase multilateral cooperation in view of the economic rise of the Pacific nations.
Association of Southeast Asian Nations
An attempt to establish a free trade area between Brunei, Cambodia, Indonesia, Laos, Maylasia, Maynmar, Phillipies, Singapore, Thailand, and Vietnam
Central American Common Market
A trade between Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua, which began in the early 1960's but collapsed in 1969 due to war.
Central American Free Trade Agreement (CAFTA)
The agreement of the member states of the Central American Common Market joined by the Dominican Republic to trade freely with the United States.
An association of English-Speaking Carribean states that are attempting to establish a customs union.
Carribean Single Market and Economy (CSME)
Unites six CARICOM members in agreeing to lower trade barriers and harmonize macroeconomic and monetary policies.
A 1969 agreement between Bolivia, Chile, Ecuador, Columbia, and Peru to establish a customs union.
Treaty agreed to in 1991, but not ratified until January 1, 1994, that committed the 12 member states of the European Community to adopt a common currency.
Elected EU body that consults on issues proposed by the European Commission.
Treaty of Libson
Traty signed in 2007 that made the European Parliament the co-equal legislator for almost all European laws and also created the position of the president of the European Council.
Court of Justice
Supreme appeals court for the EU law
Single European Act
A 1987 act, adopted by members of the European Community, that committed member countries as establishing an economic union.
Foreign Exchange Market
A market for converting currency of one country into that of another country
Rate at which one currency is converted into another
3 reasons for converting currency
- Bill payments
- Basic investment opportunities
Involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange
Borrowing in one currency where interests rates are Low, and then using the proceeds to invest in another currency where interest rates are high.
The process of insuring one's business against foreign exchange risk by using forward exchanges of or currency swaps (Insurance Policy)
Exchange rate at which a foreign exchange dealer will convert one currency into another currency on a particular day.
When two parties agree to exchange currency and execute the deal at some specific date in the future.
Forward exchange Rate
The exchange rate governing forward exchange transactions
Simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.
The purchase of securities in one market for immediate resale in another to profit from a price discrepancy.
What are the two theories of different exchange rates? (benefits of exchange rates)
- Law of one price
- Efficient Market
Law of one price
Identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.
A market which has no impediments to the free flow of goods and services, such as trade barriers, and prices reflect all available public information.
One in which prices do not reflect all available information. *In an inefficient market, forward exchange rates will not be the best possible predictors of future spot exchange rates
(Forecasting exchange rate) Draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements
Uses price and volume data to determine past trends, which are expected to continue into the future.
Freely Convertible Currency
A country's currency is freely convertible when the government of that country allows both residents and nonresidents to purchase unlimited amounts of foreign currency with it. (can be readily bought or sold without government restrictions)
Externally Convertible Currency
Nonresidents can convert their holdings of domestic currency into foreign currency, but the ability of residents to convert the currency is limited.
Residents covert domestic currency into a foreign currency.
International Monetary System
Institutional arrangements countries adopt to govern exchange rates.
Floating Exchange Rates
Exchange rate for converting one currency into another is continuously adjusted depending on the laws of supply and demand (fluctuates)
Pegged Exchange Rate
Currency value is fixed relative to a reference currency
Government artificially keeps the currency low
Fixed exchange Rate
A system under which the exchange rate for converting one currency into another is fixed.
European Monetary System (EMS)
A system to regulate fixed exchange rates before the introduction of the euro. *Was succeeded by the European Monetary Union (EMU)
Pegging currencies to gold and guaranteeing convertibility.
Gold par value
The amount of currency needed to purchase one ounce of gold
Reached when the income a country's residents earn from exports equals the money residents pay for imports.
System under which some currencies are allowed to float freely, but the majority are either managed by government intervention or pegged by another country.
The means of controlling a country's currency.
A loss of confidence in the banking system that leads to a run on banks, as individuals and companies withdraw their deposits.
Foreign Debt Crisis
Situation in which a country cannot service its foreign debt obligations
Arises when people behave recklessly because they know they will be saved if things go wrong.
The absence of government barriers to the free flow of goods and services between countries.
A tax on imports
fixed charge for each unit of good imported
Ad Valoren Tariff
Tariff on a proportion of the value of an imported good
Government financial assistance to a domestic producer
Direct restriction on the quantity of some good that may be imported into a country.
Tariff Rate Quota
Applying lower tariff rate to imports within the quota than those over the quota.
Voluntary Export Restraint
A quota on trade imposed by the exporting country, typically at the request of the importing country's government.
Extra profit producers make when supply is artificially limited by an import quota
Local Content Requirement
A requirement that some specific fraction of a good be produced domestically
Administrative Trade policies
Bureaucratic rules designed to make it difficult for imports to enter a country.
Selling goods in a foreign market at below their cost of production of below their "fair" market value
Infant Industry Argument
New industries in developing countries must be temporarily protected from international competition to help them reach a position where they can compete on world markets with the firms of developed nations.
Strategic Trade Policy
Government policy aims at improving the competitive position of a domestic industry or domestic firm in the whole market. (implementing tariffs and taxes))
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