Question 1. Using Porter’s Diamond (Figure 7.7), how would you explain the current configuration of Iowa’s industries and economy? (5 points) If you need background, here is a link to an overview http://en.wikipedia.org/wiki/Iowa#Economy
Question 2. Read this article on Botswana. Using the logic of any two (2) trade theories of your choice, what recommendations would you give the government in terms of future economic growth? Be sure to justify your assertions using the assumptions of the theories.
Read and site the two websites below as well as the article pasted beneath.
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Botswana’s Impatient President: Diamonds are not forever”
published in The Economist, October 22, 2009
“When diamonds were discovered in 1967, a year after independence, Botswana was among the ten poorest countries in the world. Now, because it supplies 22% of the world’s total output (in value) of rough diamonds, it is a middle-income country with a GDP of nearly $14,000 a head at purchasing-power parity. Diamonds produced by Debswana, a joint venture between Botswana’s government and De Beers, the world’s biggest rough-diamond trading company, account for a third of the country’s GDP, half of its public spending and three-quarters of its foreign earnings.
At least it did until the global economic crisis hit the diamond market. Also, diamond jewelry markets had fallen in comparison to other luxury goods. The behavior of consumers had changed and the diamond industry had been slow to respond to market dynamics. In past times of falling demand, De Beers used to stockpile its gems to keep prices up. But this was ruled an illegal antitrust practice. Now it simply stops digging, in effect stockpiling the gems underground. Between January and May, Debswana shut all four of its Botswana mines. This year’s output is likely to be 40% down, hugely shrinking profits ($1.7 billion last year) and public revenues.
Botswana has long been held up as one of Africa’s most stable, prosperous and best-governed democracies. In a good-governance index issued this month by the Mo Ibrahim Foundation, it came top of Africa’s mainland countries (it was topped by three island states). It is also deemed one of Africa’s lowest credit risks. But a rare spell of economic and even political turbulence may beckon as President Khama seeks to enforce his values of hard work, discipline, self-reliance and accountability on a country that must wake up to the reality that its diamonds are not forever.
At present output, Botswana’s diamond deposits may run out by 2030. The government has talked for decades about diversifying the economy, but little has been done. So Mr. Khama is promoting commercial farming and safari tourism in Botswana’s vast expanses of game-filled pristine bush. But it will be hard to create a diverse economy on a large scale in a country of just 2 million people.”
Question: A major FDI debate over the past few years has been the Keystone XL Pipeline, a large project by TransCanada in the USA, that was blocked by the Obama administration so far. Take a look through the links below. What kind of FDI is it? Using the material on slides 21-25, how would you analyze this case? What are the potential costs and benefits of allowing this FDI project to proceed?
Slide 21: Costs to the Host Country
- Adverse effects of FDI on competition within the host nation
- subsidiaries of foreign MNEs may have greater economic power than indigenous competitors because they may be part of a larger international organization
- Adverse effects on the balance of payments
- when a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country” balance of payments
- Perceived loss of national sovereignty and autonomy
- decisions that affect the host country will be made by a foreign parent that has no real commitment to the host country, and over which the host country’s government has no real control
Slide 22-23: Benefits to the Home Country
The benefits of FDI for the home country include:
- The effect on the capital account of the home country’s balance of payments from the inward flow of foreign earnings
- Employment effects that may arise from outward FDI. For example, components that need to be made at headquarters and exported for assembly overseas.
- The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country
- The home country’s balance of payments can suffer
- from the initial capital outflow required to finance the FDI
- if the purpose of the FDI is to serve the home market from a low cost labor location
- if the FDI is a substitute for direct exports
- Employment may also be negatively affected if the FDI is a substitute for domestic production
- But, international trade theory suggests that home country concerns about the negative economic effects of offshore production (FDI undertaken to serve the home market) may not be valid
The balance of payments is negatively affected by the initial capital outflow required to finance the FDI, if the purpose of the investment is to serve the home country from a low cost production location, and if the FDI is a substitute for direct exports.
These concerns are linked with the concerns about exports.
If FDI effectively replaces home country production, there will be a negative effect on employment.
Keep in mind though, that international trade theory suggests that the concerns about the negative effects of FDI may not be valid.
Companies that use offshore production, or FDI undertaken to serve the home market, may actually be freeing up resources that could be used more effectively elsewhere.
Slide 24: How Do Governments Influence FDI?
- Governments can encourage outward FDI
- government-backed insurance programs to cover major types of foreign investment risk
- Governments can restrict outward FDI
- limit capital outflows, manipulate tax rules, or outright prohibit FDI
- Governments can encourage inward FDI
- offer incentives to foreign firms to invest in their countries
- gain from the resource-transfer and employment effects of FDI, and capture FDI away from other potential host countries
- Governments can restrict inward FDI
- use ownership restraints and performance requirements
- offer incentives to foreign firms to invest in their countries
Given that there can be both positives and negatives associated with FDI, how can governments regulate it?
Well, there are various ways that home countries can encourage or discourage FDI by local firms.
We’ll begin with policies to encourage FDI.
A key reason that firms may resist FDI is because of the risk involved.
To minimize this concern, many countries have government-backed programs that cover the major forms of risk like the risk of expropriation, war losses, or the inability to repatriate profits.
Some countries have also developed special loan programs for companies investing in developing countries, created tax incentives, and encouraged host nations to relax their restrictions on inward FDI.
To discourage outward FDI, countries regulate the amount of capital that can be taken out of a country, use tax incentives to keep investments at home, and actually forbid investments in certain countries like the U.S. has done for companies trying to invest in Cuba and Iran.
Host countries can also restrict or encourage FDI.
Recall that we’ve moved away from the radical stance that discouraged FDI in general and towards a more free market approach, and pragmatic nationalism.
To encourage inward FDI, host countries usually offer incentives for investment like tax breaks, low interest loans, or subsidies.
Why would countries offer these benefits to foreign firms?
Because they want to gain the benefits of FDI that we talked about earlier! Kentucky for example, offered a $112 million package to Toyota to get it to build its U.S. plants in the state!
When a country wants to restrict FDI, it will usually implement ownership restraints or performance requirements.
In Sweden for example, foreign companies aren’t allowed to invest in the tobacco industry.
Ownership restraints accomplish two things.
First, they keep foreign firms out of certain industries on the grounds of national security or competition, allowing the local firms to develop.
Second, they help maximize the resource transfer effect and employment benefits that are associated with FDI.
In Japan for example, until the early 1980s, most FDI was prohibited unless the foreign firm had valuable technology.
Then, the foreign firm was allowed to form a joint venture with a Japanese company because the government believed this would speed up the diffusion of the technology throughout the Japanese economy.
Slide 25: FDI Decision Matrix
The decision to undertake FDI depends on the nature of a firm’s products: