|
|
|
|
Journal of International Relations and Development
Economic Integration in Trade and Foreign Direct Investment: Dynamic Considerations of Potential and Adjustment
by John Cantwell
*
and Christian Bellak
**
Introduction
Despite the often heard argument that the volume of internationalisation relative to domestic (National) output is not very different from that of a century ago (i.e. at the turn of the 20th Century), it has been acknowledged by most scholars that its nature has certainly changed. At the heart of the changing nature of internationalisation is the changing international division of labour, occurring primarily within companies. As a result of this, integrated international production has emerged and generated more complex forms of international economic interdependence than the simple vertical and horizontal integration of the past. Internationally integrated foreign direct investment (FDI) in turn stimulates trade in intermediate goods and intra-firm trade in general.
The emergence of such phenomena poses a challenge to theoretical and empirical work. The articles in this special issue meet this challenge in different ways. The views presented shed some light on these questions on theoretical, conceptual and empirical levels. Analyses like these are important preconditions for an assessment of the effects of FDI on trade and are part of the policy agenda concerned with the enlargement of the European Union (EU) towards Eastern Europe.
The four articles brought together were all presented on 20 January 2000 during a workshop held at the Vienna University of Economics and Business Administration in Vienna (Austria) when John Cantwell was a Visiting Professor in the Department of Economics. At this workshop, two additional papers were presented that are scheduled to appear in later issues of the present journal; one by Wilfried Altzinger, who reports on the intra-firm trade relations between Austrian parent firms and their subsidiaries in Central and Eastern European countries (CEECs) which emerged on the basis of the enlarged investment stock of Austrian firms located primarily in the neighbouring countries (like Hungary, the Czech Republic, and Slovenia). The other paper, by Gabor Hunya, undertakes an assessment of trade and FDI issues from the host country’s viewpoint. Taken together, these six articles present the work of a group of researchers and scholars in the field of international business who share a specific interest and expertise in the developments in Eastern Europe.
General Framework
THE VOLUME OF INTERNATIONAL TRADE DIRECTLY ORGANISED BY MULTINATIONAL CORPORATIONS (MNCS) HAS RISEN ENORMOUSLY SINCE 1945, AND ESPECIALLY SINCE 1970. This has necessitated changes in the theoretical approaches taken towards both MNCs and international trade. In the former case of the theory of the MNC, earlier scholars tended to think of the international production of MNCs, usually financed through FDI, as an alternative means of serving international markets by comparison with trade. In the latter case of the theory of international trade, traditional trade theory was cast at the level of products, and ‘firms’ entered only in a notional sense – as single-product, location-bound entities. Only recently has modern trade theory begun to incorporate aspects of the MNC (Helpman 1984) and attempts have been subsequently made to reconcile the approaches based on technology, preferences and factor endowments (Markusen 1995). The increasing importance of cross-border FDI, and the resulting regional specialisation patterns have brought new determinants to the fore, namely scale and agglomeration advantages and the importance of transport costs. The ‘New Economic Geography’ literature point to patterns of production and specialisation that result in new patterns of trade within and between firms (Braunerhjelm 1998). It is important to emphasise that these models are complementary to modern trade theory and illustrate how the traditional approach has been recently extended to accommodate the presence of cross-border ownership linkages (Venables 1999; Reganati 1999).
In the conventional Heckscher-Ohlin-Samuelson (H-O-S) theory of trade as developed by Mundell (1957), international trade and international capital movements are substitutes for one another. From this perspective, trade (and/or capital movements) is motivated by macroeconomic country-specific differences in the proportions of factor endowments, and among these factor endowments capital may be mobile but labour is immobile. Capital-rich countries export products made using capital-intensive processes since capital is locally abundant and hence cheaper, or alternatively they merely export the capital itself through foreign investment. Technology was usually either regarded as being akin to information, easily transferable at low cost once it has been created, or in some more recent treatments regarded instead as itself being akin to a further inherited country-specific factor endowment. If, instead, the traditional view is amended more radically to allow for active multi-product firms with differentiated technologies that define their competencies with respect to one another, and trade is motivated by these firm-specific differences in technological capabilities and hence patterns of specialisation within and between industries, then exports and FDI are more likely to be complementary channels. That is, more capable companies with lower unit costs and higher quality products will generate more exports and more FDI, and their international expansion may facilitate their acquisition of further capabilities (so that FDI leads to new exports, and vice versa) (Cantwell 1994).
In general terms, FDI can in principle be either trade-creating or trade-replacing. Trade creation might arise e.g. by FDI opening up a new market (facilitating exports from the home country to the new host), or by establishing a new field of local comparative advantage, or building upon and extending an existing location-specific advantage such as with the extractive investments of an experienced mining company (facilitating exports from the host economy). Trade diversion may occur e.g. if exports of final products from the home country are simply displaced by local production, a special case of which might result from the imposition of a tariff by the host country. In the event of a tariff, it is really the trade barrier that displaces the existing trade, and FDI becomes the only viable means for foreign-owned firms to continue to service the local market. Trade diversion may also occur with respect to third countries, when exports of the home country to third countries are substituted by a foreign affiliate (Svensson 1996). Accordingly, the relationship between FDI and trade is often much more complex than suggested in conceptual frameworks or empirical analysis.
FDI can be divided into three categories, each of which entails a particular relationship with international trade. First, resource-based investments relate to the exploitation of natural resources in the host country – the extraction of metallic ores or mineral deposits in the case of mining, or the use of fertile land and a helpful climate in the case of agriculture – by companies which have developed the technologies of mining or farming. Second, local market-oriented investments aim to serve the final-product market of the host country, sometimes together with a neighbouring regional market, particularly if the host country is part of a regionally integrated economic area. Such aspects are dealt with from a conceptual viewpoint in the last part of Rojec’s article. Egger’s contribution considers the relationship between economic integration via trade and via FDI empirically. Maintaining that ‘after a time span of less than a decade the entire gap between potential and real trade relationships between EU and CEECs was closed, and no integration effects were left unexploited’ (p. 174 in this issue), he examines adjustment processes associated with different kinds of shocks from economic integration. The shocks are defined as simultaneous shocks in exports and FDI. The long-run effects are thus a combined result of own (trade) and of cross (FDI) effects on trade. Surprisingly, the short-run effect of FDI on exports is negative. The simulation model also showed that trade adjusts more rapidly to their long-run level than FDI.
Third, internationally integrated investments involve the local affiliate in a specialised function for the international corporate group of which it is part. Affiliates may be either specialised in a particular stage of a value-added chain and hence vertically integrated, or they may be specialised in serving the world or regional market for a particular segment of the product range of the international group and hence horizontally integrated. Resource-based investments might be thought of in this context as a special case of the internationally vertically integrated, but the distinction is that resource-based FDI has a much longer history, dating back at least a hundred years or so (and arguably several hundred years). In contrast, (other) internationally integrated investments have typically evolved out of the local market-oriented kind, and draw on a continuing interaction between locally created capabilities and the wider capabilities of the MNC as a whole, in which process the firm is an active player in fostering and reforming local comparative advantage (unlike the received and fixed location-specific advantages due to the presence of natural resource endowments).
Resource-based and internationally integrated investments are generally net trade-creating since trade is the means by which they establish the international connections and associated cross-border division of labour that are their essential motivation, yet they could bring some trade-diverting effects as well (e.g. if they replace some of the previous patterns of arms-length trade say between a different set of countries). Local market-oriented investments are more difficult to classify a priori, since they may have both trade-creating and trade-replacing effects, and it becomes an empirical matter to assess which of the two is stronger on a case-by-case basis. Final-product trade between the home and host country may be displaced, but there may be a new trade in intermediate products and in other complementary products. Theory has tended to focus on trade replacement, such as in the product cycle model (Vernon 1966) or other models of the transition from exporting or licensing to FDI (Buckley and Casson 1981), but the empirical evidence leans towards a net trade-creation effect in practice (Lipsey and Weiss 1981; 1984; Lipsey et al. 2000). Rojec endeavours to examine this multi-facetted role of subsidiary trade and its determinants. The factors determining the export propensity of a subsidiary are grouped into four types of variables: (a) investing firm variables include the type of integration, the degree of multinationality etc.; (b) among affiliate variables are the type of ownership, the amount of vertical integration, the size of investment etc.; (c) home country variables do not yield any relation that contains testable propositions; and (d) host country variables comprise factors like market size, relative level of development, the policy environment etc.
Affiliate Learning and Life Cycles
AS JUST MENTIONED, INTERNATIONALLY INTEGRATED INVESTMENTS HAVE EVOLVED SINCE AROUND 1970 OUT OF NETWORKS OF FORMERLY LOCAL MARKET-ORIENTED INVESTMENTS. This process of evolution can be related to a process of learning within individual affiliates. Affiliates became more locally creative in place of the more passive actors they had once been when they were typically what was termed miniature replicas of their parent company. A miniature replica was an affiliate that had simply tended to reproduce in the host country essentially the same products and production methods initially pioneered by the firm in the home country. Corporate competence is now increasingly generated within affiliates, and then strategically integrated in the relevant MNC group, such that internationalisation is now promoting greater corporate technological diversity in MNCs (Cantwell and Piscitello 2000). The evolution of individual affiliates towards more specialised and creative functions takes advantage of the localised and geographically confined inter-firm networks of which affiliates are part, and allows them to draw on other institutions and technological resources in their respective host country. Apart from the process of learning and acquired technological differentiation within individual affiliates, the other critical feature that has stimulated the emergence of internationally integrated corporate structures has been the gradual development of organisational capabilities in MNCs which has facilitated the management of an international network. The latter organisational capacity is, of course, in turn also bound up with the development of new information and communications technologies (ICT).
Over time, as affiliates benefit from internal learning and technological specialisation and upgrading, a trend towards greater local technological creativity is linked to the changing composition of international trade. Products that an affiliate once produced for local markets will now be imported from other affiliates with the appropriate alternative specialisation, while exports will grow in fields that reflect its own newly acquired capabilities. In the early stages in the life cycle of a successful affiliate, imports of intermediate products and component parts tend to fall and exports of final products tend to rise, the extent of this net export improvement being one indicator of the internal dynamism of that investment (Cantwell 1989). However, with greater affiliate maturity in the next phase of development as it becomes part of an internationally integrated network within the MNC, both imports and exports will be substantially increased (Cantwell 1992).
The Empirical Literature on Foreign Direct Investment and trade
ONE DIFFICULTY THAT CONFRONTS ANY EMPIRICAL ASSESSMENT OF THE GROWING SHARE OF INTERNATIONAL TRADE FOR WHICH MNCS ARE RESPONSIBLE IS THE EXISTENCE OF ACCOUNTING PROBLEMS IN ALLOWING FOR THE SEPARATION BETWEEN INTERMEDIATE AND FINAL-PRODUCT TRADE (Feenstra 1998). Part of the apparent increase in the share of intra-firm trade in aggregate trade (now thought to be over one-third of total trade in most countries for which data are available) may be due to the same value-added being moved across borders more frequently, rather than an increase in the amount of value-added that enters into trade (within firms). The only way of controlling for what is arguably ‘double counting’ is through the firm-level consolidation of global production and income, in international corporate groups. This is not usually done by statistical agencies (at least not by those responsible for balance of payments data including trade data, which wish to account for all international flows that occur irrespective of their relationship to production or further processing), but in industry-based studies involving some co-operation from corporate sources this may be done selectively when compiling or using databases on company production or net output.
As mentioned earlier, in the early stages of the growth of a MNC through local market-oriented FDI, outward investment from the home country and exports tend to be complementary (Bergsten et al. 1978; Lipsey and Weiss 1981; 1984). For more mature MNCs with internationally integrated strategies, the effects may vary between industries due to the greater locational polarisation of activity that may evolve over time, as is the case in MNCs such as those originating from the United Kingdom that become very highly internationalised (Cantwell 1989). One central issue is the extent to which a strong home base remains viable – as it has done in the case of pharmaceuticals in the United Kingdom, but not in motor vehicles (Cantwell 1987). Thus, in pharmaceuticals home country exports and international investments continue to be positively associated with one another, but in motor vehicles the strong outward investment of many United Kingdom-owned vehicle component companies has been at the expense of exports, due to the simple relocation of activity abroad to more innovative centres for that industry.
Another feature is that MNC-directed trade has tended to increase the regional focus of trade. Internationally integrated FDI is in most cases integrated within regions between industrialised countries, despite the contribution of export processing activities in some developing countries. Hence, MNC trade within regional blocs (such as within the EU) has risen relative to the cross-regional trade of MNCs (Cantwell 1992). This implies that some investments might be labelled as both local- market-oriented and at the same time internationally (or regionally) integrated. The United States- and Japanese-owned MNCs in the EU generally have a local presence to serve the single European market, and may have to comply with local content requirements which restrict imports of components from the home country in order to do so. So, at a region-wide level, their investments are local market-oriented if the market is broadly defined. Yet within the EU these same firms have often adopted a strategy of corporate regional integration. Thus, between regions FDI is market-oriented, while within them it is internationally integrated.
For the same reasons, the respective compositions of inter-regional and intra-regional trade within MNCs have tended to shift in different directions owing to the usual form of restructuring the operations of MNCs that span across regions as well as across countries within regional economic areas. Intra-firm trade within regions tends to be mainly of a vertical kind, in the sense that it involves further local processing and not just local distribution. In comparison, between regions a higher proportion of intra-firm trade tends to be final-product trade, involving the supply of complementary products to local distribution systems rather than component parts as inputs into internal local production. In all these respects, regions are becoming more separated from one another in MNC networks, but within regions MNC networks are becoming more closely internationally integrated. Of course, while critics of regional authorities such as the EU sometimes view this as an adverse decline in potential global integration (the consequence of ‘fortress Europe’ or the like), it may be that this is simply one step along the road to more genuine global integration at a later stage, as making regionally integrated investments work may have to be the first step if the progression of cross-border interchange in industrial development is geographically incremental.
One possibility when looking at such changing trade structures is to examine the intra-industry trade between nations or regions. Although only part of intra-industry trade is actually intra-firm trade (there is indeed no reason to believe that the latter’s share is higher or lower a priori compared to total trade mentioned above), it can be argued that the internal division of labour within the MNCs is a major driver of changes in the structure of intra-industry trade. If the specialisation and activities of affiliates within the network of the MNC are re-organised, this will have an impact on intra-industry trade flows. Such aspects are dealt with in Éltet_’s article, which represents a comparative analysis of the trade structure of two countries, Hungary and Spain. The role of FDI as a catalyst of changing trade specialisation is examined. (The choice of Spain is motivated by the effects of EU integration and the resulting inward FDI on trade specialisation.) It also contains a careful analysis of intra-industry trade changes between 1990 and 1998: here, at a product level, goods of the same (horizontal) and of different (vertical) quality are distinguished. Quality is defined as (dis)similarity in terms of unit values. The results reveal partly surprisingly high rates of intra-industry trade and the increase of high 1 vertical intra-industry trade. The latter is especially relevant for CEECs, since an increase documents a diminishing quality gap, which is one important aspect of catching up.
The changing trade specialisation as demonstrated in great detail in Éltet_’s article is partly a result of the activities of large foreign MNCs, the exact importance of which is difficult to establish empirically. Yet, the results for Spain and Hungary suggest a somewhat higher impact of FDI on Hungarian exports. Overall, the article demonstrates how complex trade relationships and their empirical analyses are once one distinguishes between different types of trade.
Summary of Implications
WITH THE GROWTH OF MNC-CONTROLLED INTERNATIONAL TRADE AND OF INTERNATIONALLY INTEGRATED INTRA-MNC NETWORKS (INTEGRATED IN PART THROUGH MATERIAL TRADE FLOWS, AS WELL AS THROUGH TRANSFERS OF TECHNOLOGY, KNOWLEDGE AND INFORMATION), THERE IS A STEADILY INCREASING COMPLEMENTARITY BETWEEN FDI AND INTERNATIONAL TRADE. Internationally integrated forms of FDI tend to reinforce national patterns of specialisation even more than in the past, by increasing affiliate specialisation in accordance with the local potential for innovation, and hence fostering trade creation through the enhancement of local comparative advantages (of a created rather than a distantly inherited ‘endowment’ kind).
FDI gradually promotes more exports and more imports, especially of an intra-firm sort, and so MNCs are progressively more concerned to see the maintenance and improvement of a free-trading environment in order to be able to retain and further develop the advantages of cross-border business integration. As a result, MNCs have become increasingly concerned with trade-related policies. The positive contribution of some leading companies to the initiation and establishment of the single market programme has helped to reinvigorate the process of European integration since the early 1980s. Yet, by the same token, the new range of non-governmental organisations (NGOs) has come to express concerns that business interests have now gained too much of a voice in situations where their purely economic arguments are not mediated by the supporting articulation of other concerns over the distribution of the gains from trade, the environment and so on, a reaction that has been reflected in the recent deadlock in world trade talks.
References
BERGSTEN, C. Fred, Thomas HORST and Theodore H. MORAN (1978) American Multinationals and American Interests. Washington, DC: The Brookings Institution.
BRAUNERHJELM, Pontus (1998) Organisation of the Firm, Foreign Production and Trade. In Pontus BRAUNERHJELM and Karolina EKHOLM (eds) The Geography of Multinationals, 77–97. Boston, Dordrecht and London: Kluwer Academic Publishers.
BUCKLEY, Peter and Mark CASSON (1981) The Optimal Timing of a Foreign Direct Investment. Economic Journal 91(1), 75-87.
CANTWELL, John A. (1987) The Reorganisation of European Industries After Integration: Selected Evidence on the Role of Multinational Enterprise Activities. Journal of Common Market Studies 26(2), 127-51.
CANTWELL, John A. (1989) Technological Innovation and Multinational Corporations. Oxford: Basil Blackwell.
CANTWELL, John A. (1992) The Effects of Integration on the Structure of Multinational Corporation Activity in the EC. In Michael KLEIN and Paul J. J.
WELFENS (eds) Multinationals in the New Europe and Global Trade, 193-233. Berlin: Springer Verlag.
CANTWELL, John A. (1994) The Relationship Between International Trade and International Production. In David GREENAWAY and L. Alan WINTERS (eds) Surveys in International Trade, 303-28. Oxford: Basil Blackwell.
CANTWELL, John A. and Lucia PISCITELLO (2000) Accumulating Technological Competence: Its Changing Impact on Corporate Diversification and Internationalization. Industrial and Corporate Change 9(1), 21-51.
FEENSTRA, Robert C. (1998) Integration of Trade and Disintegration of Production in the Global Economy. Journal of Economic Perspectives 12(4), 31-50.
HELPMAN, Elhanan (1984) A Simple Theory of International Trade with Multinational Corporations. Journal of Political Economy 92, 451-71.
LIPSEY, Robert E. and Merle Y. WEISS (1981) Foreign Production and Exports in International Manufacturing Industries. Review of Economics and Statistics 63, 488-94.
LIPSEY, Robert E. and Merle Y. WEISS (1984) Foreign Production and Exports of Individual Firms. Review of Economics and Statistics 66, 304-8.
LIPSEY, Robert, Eric D. RAMSTETTER and Magnus BLOMSTRÖM (2000) "Outward FDI and Parent Exports and Employment: Japan, the United States and Sweden". Cambridge, MA: National Bureau of Economic Research, NBER Working Paper Series, No. 7623, March.
MARKUSEN, James R. (1995) The Boundaries of Multinational Enterprises and the Theory of International Trade. The Journal of Economic Perspectives 9(2), 169-89.
MUNDELL, Robert A. (1957) International Trade and Factor Mobility. American Economic Review 47, 321-35.
REGANATI, Filippo (1999) Mercati di Concorrenza Imperfetta ed Imprese Internazionali. Napoli: Liguori Editore.
SVENSSON, Roger (1996) Effects of Overseas Production on Home Country Exports: Evidence Based on Swedish Multinationals. Weltwirtschaftliches Archiv 132(2), 304-29.
VENABLES, Anthony J. (1999) Geography and Specialisation: Industrial Belts on a Circular Plain. In Richard BALDWIN, Daniel COHEN, Andre SAPIR, and Anthony VENABLES (eds) Market Integration, Regionalism and the Global Economy, 254-74. Cambridge: Cambridge University Press.
VERNON, Raymond (1966) International Investment and International Trade in the Product Cycle. Quarterly Journal of Economics 80(2), 190–210.
Endnotes
Note *: John Cantwell, Ph.D., is Professor of International Economics in the Department of Economics at the University of Reading (United Kingdom). He has been a Visiting Professor of Economics at the University of Rome La Sapienza, the University of the Social Sciences, Toulouse, Rutgers University, New Jersey and Vienna University of Economics and Business Administration. Back.
Note **: Christian Bellak is Assistant Professor in the Department of Economics at the Vienna University of Economics and Business Administration. Back.
Note 1: Here, ‘high’ refers to an initial, above-average level of intra-industry trade, which then further increased during the period under consideration. Back.
June 2000