- A MNE is defined as a firm that has operating subsidiaries, branches, or affiliates located in

foreign countries
+ The ownership of some MNEs is so dispersed internationally that they are known as
transnational corporations
+ The transnational corporations are usually managed from a global perspective rather than from
the perspective of any single country
- Rationales for the existence of MNEs
+ The unrealistic assumption for the theory of comparative advantage
+ Market imperfections
The theory of absolute or comparative advantage provides a basis for explaining and justifying
international trade in a model world assumed to enjoy:
Free trade
Perfect competition
No uncertainty
Costless information
No government interference
Factors of production cannot flow freely across national borders
UNREALISTIC COMPARATIVE ADVANTAGE
- The Theory of Absolute Advantage:
+ Proposed by Adam Smith in the Wealth of Nations in 1776
+ Every country should specialize in producing goods for which it possesses absolute advantage,
given its endowment of factors of production, i.e., land, labor, capital, or technology
+ Then every country should exchange products–trade–for goods that are cheaper in price than
those produced at home
+ In this way the total combined output is maximized due to the benefits of international
specialization in production
+ Because the factors of production cannot be moved freely across national borders, the benefits
of specialization are realized through international trade
- The Theory of Comparative Advantage:
+ Proposed by David Ricardo in ‘On the principles of Political Economy and Taxation’ in 1817
+ Even if a country possesses absolute advantages in the production of two products than the
other country, it should still choose to produce only one of them that can be produced relatively
more efficient than the other country
+ Ricardo termed this comparative advantage
+ Neither countries are worse off than before trade, and typically both are better off, albeit
perhaps unequally
+ The distribution of the benefits of the extra production depends on the terms of trade and the
ratio at which quantities of the physical goods are traded
- Although the international trade might have approached the comparative advantage model
during the 19th century, it certainly does not today, for the following reasons:
+ Government interference
+ Countries do not specialize only in those products that could be most efficiently produced for
economic or political reason, such as to achieve full employment, economic development, and
national self-sufficiency in munitions or agricultural industries
+ Possible forms include tariffs, quotas, and other restrictions for trade
+ At least two factors of production–capital and technology–now flow directly and easily
between countries
+ Even labor flows between countries become possible today, e.g., among countries within the
EU or between China and Taiwan
+ Modern factors of production are more numerous than in this simple model
For example, educational levels of workers, supporting infrastructure (roads, ports, or power
supply), the availability of capital, the availability of natural resources
+ The price of the goods and thus the terms of trade could be determined not through perfect
competition in oligopolistic markets
+ Comparative advantage shifts over time, as less developed countries become developed and
realize their latent opportunities
E.g., the comparative advantage in producing cotton textiles has shifted from the U.K. to the
U.S., to Japan, to H.K., to Taiwan, and to China
+ The classical model did not consider some issues, such as the effect of uncertainty and
information costs, the role of differentiated products in imperfectly competitive markets,
economies of scale, tax differentials, different legal systems, the brand name effect for
consumers, etc.
- Although the world is a long way from the classical trade model, the general principle of
comparative advantage is still valid
- However, complete specialization remains an unrealistic limiting case
Thus, the deviation from the perfect world gives the room for the existence of MNEs
- Comparative advantage today: Supply chain outsourcing
+ Comparative advantage is still a relevant theory to explain why particular countries are most
suitable for exports of goods and services that support the global supply chain of MNEs
+ The countries in the global supply chain are determined by their comparative advantages on
producing goods and providing services
+ For a country in the global supply chain, it will focus its labor force, capital, and technology in
an industry if that industry can provide relatively competitive goods and services than other
industries
For example, India has developed a low-cost software industry to create customized software
and a low-cost service industry of call centers for custom support
※ India nurtures much well-educated, English-speaking labor force and their salaries are only a
fraction of their U.S. counterparts
※ The development of telecommunications and the Internet facilitate this type of outsourcing
and enhances the comparative advantage of Indian
※ In fact, the modern telecommunications now take business activities to labor rather than
moving labor to the places of business

MARKET IMPERFECTIONS

- MNEs strive to take advantage of imperfections in national markets for products, factors of
production, and financial assets
- Imperfections in the market for products translate into market opportunities for MNEs
- Large international firms are better able to exploit such competitive factors as economies of
scale, managerial and technological expertise, product differentiation, and financial strength than
are their local competitors
- Once MNEs have established a physical presence abroad, they are in a better position than
purely domestic firms to identify and implement market opportunities through their own internal
information network
- Motives driving the decision to invest abroad and become a MNE can be categorized as
follows:
+ Market seekers
To produce in foreign markets either to satisfy local demand or to export to markets other than
their home market (U.S. automobile firms)
+ Raw material seekers
To extract raw materials in foreign countries, either for export or for further processing and sale
in the host country (oil or mining firms)
+ Production efficiency seekers
To produce in countries where one or more of the factors of production are underpriced relative
to their productivity (labor-intensive industries shifted to China or Vietnam)
+ Knowledge seekers
To gain access to technology or managerial expertise in foreign countries (Japanese firms
purchase U.S.-located electronics firms)
+ Political safety seekers
Develop new operations in foreign countries to avoid political interference (H.K. firms invest in
the U.K before China’s 1997 takeover)
- The above five types of motives are not mutually exclusive
Forest products firms seeking wood fiber in Brazil may also find a large Brazilian market for a
portion of their output
- In industries characterized by worldwide oligopolistic competition, each of the above strategic
motives should be subdivided into proactive and defensive investments
+ Proactive investments are designed to enhance the growth and profitability of the firm itself
+ Defensive investments are designed to deny growth and profitability to the firm’s competitors
E.g., to control raw material sources and deny selling to competitors
International Financial Management vs. Domestic Financial Management
- Due to the increase of global integration of money and capital markets, purely domestic firms
also have significant international activities:
+ Import and export of products, components, and services
+ Licensing foreign firms to conduct their foreign business
+ Exposure to foreign competition in the domestic market
+ Indirect exposure to international risks through relationships with customers and suppliers

Globalization and Creating Firm Value

※ Levels I, II, and III represent the level and economic development and openness of the
countries where the firm is located
※ Generally speaking, it is more possible to create firm value in a mature economy because
firms can access easily to the capital and the marketplace, and are usually with better
management due to the competition and the regulation of the government
※ For example, General Electric in the U.S. reside in Level III, Cemex in Mexico is a resident in
Level II, and Haier Group in China is an MNE resident in Level I
- Murthy, CEO of Infosys, defines the globalization of a firm as producing where it is most cost-
effective, selling where it is most profitable, and sourcing capital where it is cheapest, without
worrying about national boundaries
+ This statement describe the globalization realistically
+ This statement is also consistent with the three elements for creating firm value
. To find marketplaces with the less cost and higher selling prices, and to seek for cheaper capital
. To manage MNEs with a global perspective rather than the perspective of any single country
+ The globalization is in essence a process to maximize the firm value without being limited by
national boundaries
- Trident is a hypothetical U.S.-based firm as an example throughout the text book to
demonstrate the globalization process
+ The example of Trident illustrates the structural and managerial changes and challenges
experienced by a firm as it evolves from domestic in scope to being truly multinational
+ Trident was founded in L.A. in 1948 to make telecommunications equipment
. It remains to be a family-owned business in the following 40 years
. Like many other young firms it is constrained by its small size, and lack of access to cheap and
plentiful sources of capital
. However, the demands of continual technological investment in the 1980s required it to raise
additional equity capital in order to compete
. This led to its initial public offering (IPO) in 1988, as a U.S.-based publicly traded company on
NASDAQ
. Trident expanded its business by exporting or importing product and services from foreign
market–entering into the international trade phase of the globalization process (see Exhibit 1.4)
. If Trident is successful in its international trade activities, it may enter into the next phase of the
globalization process–the multinational phase