Chapter 1

Current
Multinational
Challenges and
the Global
Economy
 The Multinational Enterprise
(MNE)
I define globalization 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.
Narayana Murthy, President and CEO, Infosys.
A multinational enterprise (MNE) has operating
subsidiaries, branches or affiliates located in foreign
countries.
The financial crisis of 2007-2009 has disrupted
international business and identified disturbing
risks.

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 Financial Globalization and Risk

The global financial market place is a combination

of complex risks:
The international monetary system is an eclectic mix of
floating and managed fixed exchange rates. China is more
and more a dominant player.
Monetary and fiscal policies are complicated by large
government deficits.
Large and continuing balance of payments imbalances will
shift the exchange rate landscape.
The dominant form of business may have shifted from the
publicly-traded firm to the privately owned model.
Global capital markets are shrinking and changing.
Perhaps too much capital sometimes flows to emerging
market countries causing another set of problems

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 The Global Financial Marketplace

Assets, institutions, and linkages comprise one

method to map global capital markets (see Exhibit
1.1).
The assets are debt securities issued by
governments (e.g. U.S. Treasury securities). These
form the baseline for other forms of financing.
The institutions are the central banks, commercial,
and investment banks. Their health keeps the
global financial system stable.
The linkages are the interbank networks using
currency. Without ready exchange of currencies
the market is hard-pressed to operate efficiently.

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 Exhibit 1.1 Global Capital Markets

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 The Market for Currencies

Most currencies are quoted against the

dollar as in so many units per dollar
A few are quoted as dollars per unit due to
custom e.g., $/ and $/.
There are also several symbols that can be
used to write the quotations, but this is the
authors stated preference.
Exhibit 1.2 provides selected currency
exchange rate quotes

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 Exhibit 1.2 Selected Global Currency
Exchange Rates

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 Exhibit 1.2 Selected Global Currency
Exchange Rates (cont.)

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 Eurocurrencies and LIBOR

Eurocurrencies (a major linkage in the

global and capital markets)
These are domestic currencies of one country on
deposit in a second country
The Eurocurrency markets serve two valuable
purposes:
Eurocurrency deposits are an efficient and convenient
money market device for holding excess corporate
liquidity
The Eurocurrency market is a major source of short-
term bank loans to finance corporate working capital
needs (including export and import financing)

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 Eurocurrencies and LIBOR

Eurocurrency Interest Rates: LIBOR

In the Eurocurrency market, the reference rate
of interest is the London Interbank Offered Rate
(LIBOR)
This rate is the most widely accepted rate of
interest used in standardized quotations, loan
agreements, and financial derivatives
transactions

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 The Theory
of Comparative Advantage
The theory of 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; and
no government interference.

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 The Theory
of Comparative Advantage
The theory contains the following features:
Exporters in Country A sell goods or services to unrelated
importers in Country B
Firms in Country A specialize in making products that can
be produced relatively efficiently, given Country As
endowment of factors of production, that is, land, labor,
capital, and technology
Firms in Country B do likewise, given the factors of
production found in Country B
In this way the total combined output of A and B is
maximized

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 The Theory
of Comparative Advantage
Because the factors of production cannot be moved freely
from Country A to Country B, the benefits of specialization
are realized through international trade
The way the benefits of the extra production are shared
depends on the terms of trade, the ratio at which
quantities of the physical goods are traded
Each countrys share is determined by supply and demand
in perfectly competitive markets in the two countries
Neither Country A nor Country B is worse off than before
trade, and typically both are better off, albeit perhaps
unequally

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 The Theory
of Comparative Advantage
Although international trade might have
approached the comparative advantage model
during the nineteenth century, it certainly does not
today, for the following reasons:
Countries do not appear to specialize only in those
products that could be most efficiently produced by that
countrys particular factors of production (as a result of
government interference and ulterior motivations)
At least two factors of production capital and technology
now flow directly and easily between countries

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 The Theory
of Comparative Advantage
Modern factors of production are more numerous than in
this simple model
Although the terms of trade are ultimately determined by
supply and demand, the process by which the terms are
set is different from that visualized in traditional trade
theory
Comparative advantage shifts over time, as less developed
countries become developed and realize their latent
opportunities
The classical model of comparative advantage did not
really address certain other issues, such as the effect of
uncertainty and information costs, the role of differentiated
products in imperfectly competitive markets, and
economies of scale

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 The Theory
of Comparative Advantage

Comparative advantage is however 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
both MNEs and domestic firms.
The comparative advantage of the 21st century, however, is
one based more on services, and their cross-border
facilitation by telecommunications and the Internet.
The source of a nations comparative advantage is still
created from the mixture of its own labor skills, access to
capital, and technology.

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 The Theory
of Comparative Advantage

Many locations for supply chain outsourcing

exist today (see Exhibit 1.3).
It takes a relative advantage in costs, not
just an absolute advantage, to create
comparative advantage.
Clearly, the extent of global outsourcing is
reaching out to every corner of the globe.

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 Exhibit 1.3 Global Outsourcing of
Comparative Advantage

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 What is Different About International
Financial Management?

Exhibit 1.4 summarizes the differences.

Culture and history differ among countries
Corporate governance
Greater levels of foreign exchange and political
risks
Financial theory and applications are modified in
the global versus domestic marketplace
Specialized and complicated financial
instruments become tools of the trade

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 Exhibit 1.4 What Is Different About
International Financial Management?

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 Market Imperfections: A Rationale for
the Existence of the Multinational Firm

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 their
local competitors.

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 Market Imperfections: A Rationale for
the Existence of the Multinational Firm

Strategic motives drive the decision to invest

abroad and become a MNE and can be summarized
under the following categories:
Market seekers
Raw material seekers
Production efficiency seekers
Knowledge seekers
Political safety seekers

These categories are not mutually exclusive.

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 The Globalization Process

Stage I: early domestic phase growing into

the international trade phase (Exhibit 1.5)
Stage II: A successful firm will continue to
grow from simple international trade to the
multinational phase characterized by
production and investment both at home
and abroad (Exhibit 1.6)
Growth may be limited by the twin agency
problems of corporate insiders and the
rulers of sovereign states (Exhibit 1.7)

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 Exhibit 1.5 Trident Corp: Initiation of the
Globalization Process

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 Exhibit 1.6 Tridents Foreign Direct
Investment Sequence

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 Exhibit 1.7 Potential Limits of
Financial Globalization

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