Economics Evaluate explanations offered

Economics of MNEs, China and Exchange Rates

Evaluate the various explanations that have been offered for the existence of the multinational enterprise.

China is a notoriously difficult place to do business. Explain what makes the business environment so challenging and explain the strategies a firm may use in order to overcome those challenges.

Explain how exchange rates are determined in a floating exchange rate system and identify the key causes of exchange rate movements.

Evaluate the various explanations that have been offered for the existence of the multinational enterprise.

A multinational enterprise is one which has a presence in terms of an office in more than one country, even if it does not employ itself in manufacturing in the country. As far as the explanations regarding the existence of MNEs are concerned, there are various that have been employed as the concept of multinational enterprises has evolved from what it was before.

One such theory is the trade theory that is generally the argument of the economists who insist that MNEs are a source of foreign direct investment and were a long-term capital investment that led to inflow of funds in the economy. These are seen as a form of capital inflow following when there was a difference in interest rates and yields of return which enabled an investment friendly climate.

However there are drawbacks with this theory and economists such as Steven Hymer have addressed the fact that real interests rates were not the reason behind the exponential growth of MNEs as there seemed to be no correlation between FDI growth and MNEs. Moreover interest rates are subject to fluctuations as are rates of returns which essentially do not explain the rationale behind investment in foreign countries. Again as banks are in a better position to predict these and invest, why would banks not invest their funds and manage their investment portfolios in a manner that would maximize these returns. Another factor to do with the trade theory is that interest rates can be easily maneuvered by countries, and in some cases can be increased artificially causing a sudden loss in value if they are decreased. Therefore this volatility inherent in basing long-term investment judgments purely on short-term interest rate returns defeats logical decision making by firms who are looking for a continuous business presence in a country. Lastly, interest rate differentials mainly induce short terms investments in capital stock, referred to as hot money. This money is generally fluid, and flows from one country to the other when there are interest rate fluctuations. (Hennart, 2000)

Steven Hymer, who was the critic of the trade theory, argued that MNEs were mainly a form for firms to reduce competition in the local markets and to seek revenue streams abroad where conditions were more conducive. He argued that in case of local markets where barriers to entry were high and typically created to sustain monopolies, competing firms looked for avenues elsewhere where they could locate. Moreover he postulated that firms were looking to internalize 'pecuniary externalities'. The term pecuniary externalities refer to the increase in prices of goods due to a rise in demand caused by external factors. Therefore where these externalities exist, firms move in to take advantage and that was the reason for the existence of MNEs.

It can be said that Hymer's arguments were correct, but were limited. Decreasing competition in the local market is not the only reason why firms would look to locate abroad. Other reasons include the fact that the companies might think that another market was more feasible for their venture or they might find a good window of opportunity in order to develop their markets.

Yet another theory that has been forwarded by different experts at different times is that of transaction costs theory. This proposes that markets are imperfect and that agents for firms work under a constraint of bounded rationality which indicates that they have imperfect information. Therefore in order to overcome this weakness they indulge into transactions with other companies which are known to have better knowledge in some issues. In order for this exchange of information to happen, there will be price charged by the companies who are experts. The application of this for MNEs is that firms might be looking to maximize efficiencies and for this might have to collaborate with partners located in a different part of the world. To negotiate a deal with them and to use their expertise for their benefit these...

In order to meet these costs and in order to turn them into revenue streams acquisitions of specialist companies or joint ventures and other forms of international transactions occur leading to the existence of MNEs.
The shortfall in this approach is that it only looks at the increasing efficiency motive in order to reduce costs. In fact some companies might be looking at diversification or market development for their line of products warranting expansion overseas.

Other theories and arguments include the fact that MNEs exist to allow for tax savings, or they might see a large potential market for something that has reached maturity or is declining in their home countries. Additionally they might be looking for new ways to elongate their product life cycle among other motives. Another reason, especially for MNEs belonging to developed countries is that as their populations are aging and labor in these countries is expensive, MNEs expand abroad in search for better factor prices as well as a large market with low rates of penetration. Here these MNEs can easily apply their learning from their experiences in more mature markets and compete extensively and easily with local firms.

As a closing comment on this aspect of MNEs: globalization and the widespread use of the internet have enabled companies to go worldwide even before they are locally known. Companies that want international presence can open a small office in the intended country and become multinational with the rest of the business processes in that country outsourced.

The formal model of a company catering to local, national, regional and then global demand seems to be aged now when companies that have online model seem to be doing that with a mere click of a button. Of course supply chain, logistics and other processes need to be in place, but with outsourcing being a new way of doing business, there are no boundaries for businesses anymore. Brick and click models are increasingly the vogue with purely brick and mortar business being rarely the case.

China is a notoriously difficult place to do business. Explain what makes the business environment so challenging and explain the strategies a firm may use in order to overcome those challenges.

China is one of the largest countries of the world - a vast land that houses an immense population, and yet in terms of diversity, the people there are largely homogenous in their cultures with 95% of the population being Han Chinese. After years of stagnation, after the Qing dynasty ended, the Chinese economy suffered at the behest of the opium wars and was the finally galvanized by implementing indigenous reforms, aimed to bring the Chinese economy back to its former glory.

But the scars of history took time to heal. The concessions given to the British at their conquest of the war were looked down upon as a humiliating defeat for the Chinese. For a culture that places emphasis on trust and ethics and on saving face, this defeat was felt deeply. The wounds have still been carried on, where the Chinese are still resisting external companies setting up in their lands, but today it is through modern means of regulation.

Had it been a country other than China, it would probably have been pressurized to yield to international free trade treaties and would have been coerced to lower tariffs. However, being the engine for the world economy and being a major supplier on which the U.S. economy depends, China has been able to carry on its legacy of regulations and barriers.

China's early ideologies were socialism, where all enterprises were state owned and farmers and workers sold to and were employed by the states. They were cared for in a similar fashion and there was concern with equitable distribution of income. However, modern concepts of progress are based on capitalist gains, which cannot be had without income disparity and one group being rich enough and having the resources enough to set up their own enterprise. As Deng Xiaoping came into power in the 1970's and initiated Mao's reforms in 1978, private enterprise was encouraged gradually. Another push factor was also that the Soviet Bloc had fallen and there were lessons to be learnt from its radical experiments with communism and then with a completely free market. (Watkins, n.d.)

Having laid the backdrop of China from a historic perspective, some of the modern reservations can be explained, and some light can be shed on why Chinese government is resistant to change and to external influences. (Gwartney, Stroup, Sobel, & MacPherson, 2008…