Chapter 1
Current Multinational Financial Challenges
and the Global Economy
Questions
1. Globalization and the MNE. The term globalization has become very widely used in recent years.
How would you define it?
Merriam-Webster.com defines globalization as “the development of an increasingly integrated global
economy marked especially by free trade, free flow of capital, and the tapping of cheaper foreign
labor markets.”
Also, Narayana Murthy’s quote may be a good place to start a discussion of globalization:
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
2. Globalization and Value Creation. What does a MNE need in order for it to create value through
the globalization process?
Global business, like any business, is the social science of managing people to organize, maintain,
and grow the collective productivity toward accomplishing productive goals, typically to generate
profit and value for its owners and stakeholders. A multinational enterprise (MNE) needs three
fundamental elements in order to build firm value: (1) an open marketplace; (2) high quality
strategic management; and (3) access to capital.
3. Value Creation and the Concept of Capitalism. How does the concept of capitalism actually apply
to the globalization process of a business, as it moves from elemental to multinational stages of
development?
Open markets and insightful leadership is all for naught if the MNE cannot gain ready access to
affordable capital. It is capital that allows the investment needed to obtain the technology, execute
the strategy, and expand across global markets. It is the “capital” in capitalism; it is the ability of the
enterprise to reach out and obtain resources from outside of the firm to pursue the firm’s vision and
create the value for all of the key stakeholders in the enterprise itself, and subsequently for the
community and society of which it is an integral element.
4. Theory of Comparative Advantage. Define and explain 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. The theory contains the following features:
• Exporters in Country A sell goods or services to unrelated importers in Country B, while exporters
in Country B sell goods or services to importers in Country A.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
,2 Moffett/Stonehill/Eiteman • Fundamentals of Multinational Finance, Fourth Edition
• Firms in Country A specialize in making products that can be produced relatively efficiently, given
Country A’s 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.
• 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 country’s 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.
MNEs strive to take advantage of imperfections in national markets for products, factors of
production, and financial assets. 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.
5. Limitations of Comparative Advantage. Key to understanding most theories is what they say and
what they don’t. What are four or five key limitations to 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 country’s particular factors of production. Instead, governments interfere with
comparative advantage for a variety of economic and political reasons, such as to achieve full
employment, economic development, national self-sufficiency in defense-related industries, and
protection of an agricultural sector’s way of life. Government interference takes the form of tariffs,
quotas, and other non-tariff restrictions.
• At least two of the factors of production, capital and technology, now flow directly and easily
between countries, rather than only indirectly through traded goods and services. This direct flow
occurs between related subsidiaries and affiliates of multinational firms, as well as between
unrelated firms via loans, and license and management contracts. Even labor flows between
countries such as immigrants into the United States (legal and illegal), immigrants within the
European Union, and other unions.
• Modern factors of production are more numerous than in this simple model. Factors considered in
the location of production facilities worldwide include local and managerial skills, a dependable
legal structure for settling contract disputes, research and development competence, educational
levels of available workers, energy resources, consumer demand for brand name goods, mineral
and raw material availability, access to capital, tax differentials, supporting infrastructure (roads,
ports, communication facilities), and possibly others.
• 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. They are
determined partly by administered pricing in oligopolistic markets.
• Comparative advantage shifts over time as less developed countries become more developed and
realize their latent opportunities. For example, over the past 150 years comparative advantage in
producing cotton textiles has shifted from the United Kingdom to the United States, to Japan, to
Hong Kong, to Taiwan, and to China.
• 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.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
, Chapter 1 Current Multinational Financial Challenges and the Global Economy 3
Nevertheless, although the world is a long way from the classical trade model, the general principle
of comparative advantage is still valid. The closer the world gets to true international specialization,
the more world production and consumption can be increased, provided the problem of equitable
distribution of the benefits can be solved to the satisfaction of consumers, producers, and political
leaders. Complete specialization, however, remains an unrealistic limiting case, just as perfect
competition is a limiting case in microeconomic theory.
6. Trident’s Globalization. After reading the chapter’s description of Trident’s globalization process,
how would you explain the distinctions between international, multinational, and global companies.
The difference in definitions for these three terms is subjective, with different writers using different
terms at different times. No single definition can be considered definitive, although as a general
matter the following probably reflect general usage.
International simply means that the company has some form of business interest in more than one
country. That international business interest may be no more than exporting and importing, or it may
include having branches or incorporated subsidiaries in other countries. International trade is usually
the first step in becoming “international,” but the term also encompasses foreign subsidiaries created
for the single purpose of marketing, distribution, or financing. The term international is also used to
encompass what are defined as multinational and global below.
Multinational is usually taken to mean a company that has operating subsidiaries and performs
a full set of its major operations in a number of countries. A multinational company is often
presumed to operate in a greater number of countries than simply an international company. A
multinational company is presumed to operate with each foreign unit “standing on its own”—
although that term does not preclude specialization by country and/or supplying parts from one
country operation to another.
Global is a newer term similar to “multinational” but infers an even larger international presence; i.e.,
operating around the globe.
7. Trident, the MNE. At what point in the globalization process did Trident become a multinational
enterprise (MNE)?
Trident became a MNE when it began to establish foreign sales and service subsidiaries, followed by
creation of manufacturing operations abroad or by licensing foreign firms to produce and service
Trident’s products. This multinational phase usually follows the international phase, which involves
the import and/or export of goods and/or services.
8. Trident’s Advantages. What are the main advantages that Trident gains by developing a multinational
presence?
a. Entry into new markets, not currently served by the firm, which in turn allow the firm to grow
and possibly to acquire economies of scale.
b. Acquisition of raw materials, not available elsewhere.
c. Achievement of greater efficiency, by producing in countries where one or more of the factors of
production are underpriced relative to other locations.
d. Acquisition of knowledge and expertise centered primarily in the foreign location.
e. Location of the firms’ foreign operations in countries deemed politically safe.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
, 4 Moffett/Stonehill/Eiteman • Fundamentals of Multinational Finance, Fourth Edition
9. Trident’s Phases. What are the main phases that Trident passed through as it evolved into a truly
global firm? What are the advantages and disadvantages of each?
a. International trade. Two advantages are finding out if the firms’ products are desired in the
foreign country and learning about the foreign market. Two disadvantages are lack of control
over the final sale and service to final customer (many exports are to distributors or other types
of firms that in turn resell to the final customer) and the possibility that costs and thus final
customer sales prices will be greater than those of competitors that manufacture locally.
b. Foreign sales and service offices. The greatest advantage is that the firm has a physical presence
in the country, allowing it greater control over sales and service as well as allowing it to learn more
about the local market. The disadvantage is the final local sales prices, based on home country
plus transportation costs, may be greater than competitors that manufacture locally.
c. Licensing a foreign firm to manufacture and sell. The advantages are that product costs are
based on local costs and that the local licensed firm has the knowledge and expertise to operate
efficiently in the foreign country. The major disadvantages are that the firm might lose control
of valuable proprietary technology and that the goals of the foreign partner might differ from
those of the home country firm. Two common problems in the latter category are whether or
not the foreign firm (that is manufacturing the product under license) is a shareholder wealth or
corporate wealth maximizer, which in turn often leads to disagreements about reinvesting
earning to achieve greater future growth versus making larger current dividends to owners and
payments to other stakeholders.
d. Part ownership of a foreign, incorporated, subsidiary; i.e., a joint venture. The advantages and
disadvantages are similar to those for licensing: Product costs are based on local costs and that
the local joint owner presumably has the knowledge and expertise to operate efficiently in the
foreign country. The major disadvantages are that the firm might lose control of valuable
proprietary technology to its joint venture partner, and that the goals of the foreign owners
might differ from those of the home country firm.
e. Direct ownership of a foreign, incorporated, subsidiary. If fully owned, the advantage is that
the foreign operations may be fully integrated into the global activities of the parent firm, with
products resold to other units in the global corporate family without questions as to fair transfer
prices or too great specialization. (Example: The Ford transmission factory in Spain is of little
use as a self-standing operation; it depends on its integration into Ford’s European operations.)
The disadvantage is that the firm may come to be identified as a “foreign exploiter” because
politicians find it advantageous to attack foreign owned businesses.
10. Financial Globalization. How do the motivations of individuals, both inside and outside the
organization or business, define the limits of financial globalization?
If influential insiders in corporations and sovereign states pursue the goal of maximizing firm value,
there will be a definite and continuing growth in financial globalization. But if these same influential
insiders pursue their own personal agendas which may increase their personal power, influence, or
wealth, then capital will not flow into these sovereign states and corporations. This will, in turn,
create limitations to globalization in finance. The result is the growth of financial inefficiency and
the segmentation of globalization outcomes creating winners and losers.
The three fundamental elements—financial theory, global business, management beliefs and
actions—combine to present either the problem or the solution to the growing debate over the
benefits of globalization to countries and cultures worldwide.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
Current Multinational Financial Challenges
and the Global Economy
Questions
1. Globalization and the MNE. The term globalization has become very widely used in recent years.
How would you define it?
Merriam-Webster.com defines globalization as “the development of an increasingly integrated global
economy marked especially by free trade, free flow of capital, and the tapping of cheaper foreign
labor markets.”
Also, Narayana Murthy’s quote may be a good place to start a discussion of globalization:
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
2. Globalization and Value Creation. What does a MNE need in order for it to create value through
the globalization process?
Global business, like any business, is the social science of managing people to organize, maintain,
and grow the collective productivity toward accomplishing productive goals, typically to generate
profit and value for its owners and stakeholders. A multinational enterprise (MNE) needs three
fundamental elements in order to build firm value: (1) an open marketplace; (2) high quality
strategic management; and (3) access to capital.
3. Value Creation and the Concept of Capitalism. How does the concept of capitalism actually apply
to the globalization process of a business, as it moves from elemental to multinational stages of
development?
Open markets and insightful leadership is all for naught if the MNE cannot gain ready access to
affordable capital. It is capital that allows the investment needed to obtain the technology, execute
the strategy, and expand across global markets. It is the “capital” in capitalism; it is the ability of the
enterprise to reach out and obtain resources from outside of the firm to pursue the firm’s vision and
create the value for all of the key stakeholders in the enterprise itself, and subsequently for the
community and society of which it is an integral element.
4. Theory of Comparative Advantage. Define and explain 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. The theory contains the following features:
• Exporters in Country A sell goods or services to unrelated importers in Country B, while exporters
in Country B sell goods or services to importers in Country A.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
,2 Moffett/Stonehill/Eiteman • Fundamentals of Multinational Finance, Fourth Edition
• Firms in Country A specialize in making products that can be produced relatively efficiently, given
Country A’s 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.
• 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 country’s 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.
MNEs strive to take advantage of imperfections in national markets for products, factors of
production, and financial assets. 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.
5. Limitations of Comparative Advantage. Key to understanding most theories is what they say and
what they don’t. What are four or five key limitations to 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 country’s particular factors of production. Instead, governments interfere with
comparative advantage for a variety of economic and political reasons, such as to achieve full
employment, economic development, national self-sufficiency in defense-related industries, and
protection of an agricultural sector’s way of life. Government interference takes the form of tariffs,
quotas, and other non-tariff restrictions.
• At least two of the factors of production, capital and technology, now flow directly and easily
between countries, rather than only indirectly through traded goods and services. This direct flow
occurs between related subsidiaries and affiliates of multinational firms, as well as between
unrelated firms via loans, and license and management contracts. Even labor flows between
countries such as immigrants into the United States (legal and illegal), immigrants within the
European Union, and other unions.
• Modern factors of production are more numerous than in this simple model. Factors considered in
the location of production facilities worldwide include local and managerial skills, a dependable
legal structure for settling contract disputes, research and development competence, educational
levels of available workers, energy resources, consumer demand for brand name goods, mineral
and raw material availability, access to capital, tax differentials, supporting infrastructure (roads,
ports, communication facilities), and possibly others.
• 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. They are
determined partly by administered pricing in oligopolistic markets.
• Comparative advantage shifts over time as less developed countries become more developed and
realize their latent opportunities. For example, over the past 150 years comparative advantage in
producing cotton textiles has shifted from the United Kingdom to the United States, to Japan, to
Hong Kong, to Taiwan, and to China.
• 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.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
, Chapter 1 Current Multinational Financial Challenges and the Global Economy 3
Nevertheless, although the world is a long way from the classical trade model, the general principle
of comparative advantage is still valid. The closer the world gets to true international specialization,
the more world production and consumption can be increased, provided the problem of equitable
distribution of the benefits can be solved to the satisfaction of consumers, producers, and political
leaders. Complete specialization, however, remains an unrealistic limiting case, just as perfect
competition is a limiting case in microeconomic theory.
6. Trident’s Globalization. After reading the chapter’s description of Trident’s globalization process,
how would you explain the distinctions between international, multinational, and global companies.
The difference in definitions for these three terms is subjective, with different writers using different
terms at different times. No single definition can be considered definitive, although as a general
matter the following probably reflect general usage.
International simply means that the company has some form of business interest in more than one
country. That international business interest may be no more than exporting and importing, or it may
include having branches or incorporated subsidiaries in other countries. International trade is usually
the first step in becoming “international,” but the term also encompasses foreign subsidiaries created
for the single purpose of marketing, distribution, or financing. The term international is also used to
encompass what are defined as multinational and global below.
Multinational is usually taken to mean a company that has operating subsidiaries and performs
a full set of its major operations in a number of countries. A multinational company is often
presumed to operate in a greater number of countries than simply an international company. A
multinational company is presumed to operate with each foreign unit “standing on its own”—
although that term does not preclude specialization by country and/or supplying parts from one
country operation to another.
Global is a newer term similar to “multinational” but infers an even larger international presence; i.e.,
operating around the globe.
7. Trident, the MNE. At what point in the globalization process did Trident become a multinational
enterprise (MNE)?
Trident became a MNE when it began to establish foreign sales and service subsidiaries, followed by
creation of manufacturing operations abroad or by licensing foreign firms to produce and service
Trident’s products. This multinational phase usually follows the international phase, which involves
the import and/or export of goods and/or services.
8. Trident’s Advantages. What are the main advantages that Trident gains by developing a multinational
presence?
a. Entry into new markets, not currently served by the firm, which in turn allow the firm to grow
and possibly to acquire economies of scale.
b. Acquisition of raw materials, not available elsewhere.
c. Achievement of greater efficiency, by producing in countries where one or more of the factors of
production are underpriced relative to other locations.
d. Acquisition of knowledge and expertise centered primarily in the foreign location.
e. Location of the firms’ foreign operations in countries deemed politically safe.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
, 4 Moffett/Stonehill/Eiteman • Fundamentals of Multinational Finance, Fourth Edition
9. Trident’s Phases. What are the main phases that Trident passed through as it evolved into a truly
global firm? What are the advantages and disadvantages of each?
a. International trade. Two advantages are finding out if the firms’ products are desired in the
foreign country and learning about the foreign market. Two disadvantages are lack of control
over the final sale and service to final customer (many exports are to distributors or other types
of firms that in turn resell to the final customer) and the possibility that costs and thus final
customer sales prices will be greater than those of competitors that manufacture locally.
b. Foreign sales and service offices. The greatest advantage is that the firm has a physical presence
in the country, allowing it greater control over sales and service as well as allowing it to learn more
about the local market. The disadvantage is the final local sales prices, based on home country
plus transportation costs, may be greater than competitors that manufacture locally.
c. Licensing a foreign firm to manufacture and sell. The advantages are that product costs are
based on local costs and that the local licensed firm has the knowledge and expertise to operate
efficiently in the foreign country. The major disadvantages are that the firm might lose control
of valuable proprietary technology and that the goals of the foreign partner might differ from
those of the home country firm. Two common problems in the latter category are whether or
not the foreign firm (that is manufacturing the product under license) is a shareholder wealth or
corporate wealth maximizer, which in turn often leads to disagreements about reinvesting
earning to achieve greater future growth versus making larger current dividends to owners and
payments to other stakeholders.
d. Part ownership of a foreign, incorporated, subsidiary; i.e., a joint venture. The advantages and
disadvantages are similar to those for licensing: Product costs are based on local costs and that
the local joint owner presumably has the knowledge and expertise to operate efficiently in the
foreign country. The major disadvantages are that the firm might lose control of valuable
proprietary technology to its joint venture partner, and that the goals of the foreign owners
might differ from those of the home country firm.
e. Direct ownership of a foreign, incorporated, subsidiary. If fully owned, the advantage is that
the foreign operations may be fully integrated into the global activities of the parent firm, with
products resold to other units in the global corporate family without questions as to fair transfer
prices or too great specialization. (Example: The Ford transmission factory in Spain is of little
use as a self-standing operation; it depends on its integration into Ford’s European operations.)
The disadvantage is that the firm may come to be identified as a “foreign exploiter” because
politicians find it advantageous to attack foreign owned businesses.
10. Financial Globalization. How do the motivations of individuals, both inside and outside the
organization or business, define the limits of financial globalization?
If influential insiders in corporations and sovereign states pursue the goal of maximizing firm value,
there will be a definite and continuing growth in financial globalization. But if these same influential
insiders pursue their own personal agendas which may increase their personal power, influence, or
wealth, then capital will not flow into these sovereign states and corporations. This will, in turn,
create limitations to globalization in finance. The result is the growth of financial inefficiency and
the segmentation of globalization outcomes creating winners and losers.
The three fundamental elements—financial theory, global business, management beliefs and
actions—combine to present either the problem or the solution to the growing debate over the
benefits of globalization to countries and cultures worldwide.
© 2012 Pearson Education, Inc. Publishing as Prentice Hall
