Undergraduate investments made by multinational corporations in foreign countries,

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Choose
a firm that owns production facilities (i.e. has
undertaken FDI) in one or more foreign countries. Explain and critically
evaluate the relative importance of the economic factors that affected this
choice. 

 

Foreign Direct Investment (FDI) is
often referred to as investments made by multinational corporations in foreign countries,
such as affiliations and subsidiaries (De Mooij & Ederveen, 2003). In order to remain
competitive amongst rivals, firms facilitate a number of economic strategies to
gain market advantages. Numerous literature has explored the phenomenon of FDI,
developing theories to understand the motivation behind international
production (Rugman, 1980). Several studies have
presented ideologies based on the general theory of internalisation; where FDI
is undertaken due to imperfections in the market. The theory of internalisation
was first advanced by Coase (1937), domestically, and later developed by Hymer
(1976) in an international dimension. Additionally, Dunning (2000) presented three
conditions that must be met in order for a multinational, which seeks to maximise
profit, to undertake FDI: Ownership, Location and Internalisation. Modern
literature advocates alternative economic theories determining FDI such as
cost-minimisation and public policy (Porter, 2017). Founded in 1943, IKEA’s
unparalleled global strategy has enabled it to become the world’s largest
furniture retailer (Loeb, 2012).
With over 312 stores in 38 countries, IKEA has the capacity to reach millions worldwide
with a staggering 936 million in-store visits in 2017 (IKEA, 2017).
While most of its operations, design and management are run in Sweden, numerous
manufacturing aspects have been outsourced to China and other Asian countries (Loeb, 2012). Through ensuring
each opportunity to enter a foreign market is achieved and continuously
enhancing enterprise internationalisation, IKEA has remained competitive (Lingxiu, 2017). Through analysing
specific production locations, such as Poland and China, both cost-minimisation
and public policies were key factors in their decision to undertake FDI.

Interdependences between governments
and firms are significant in understanding FDI due to the ability of
multinationals to strategically manipulate the behaviour of national
policymakers. FDI is extremely attractive to governments, as not only does it
increase domestic income through taxation but spill over effects can lead to
technological enhancements and a more advanced labour force (Porter, 2017). In
modern-day economics, FDI is increasingly flexible, where firms have the ability
to locate in numerous countries, incentivising governments to create the most
tax favourable environment. According to Teeffelen (2017), government incentive
activities such as lower taxes have considerably increased since the mid-1980s,
illustrated in Figure 1.  

 

Figure
1: Global Corporate Tax Rate 1980-2015 (Source: Eurodad Calculations based on
IMF Data)

 

In a recent study by Oman (2000), it
was prevalent that large foreign companies, such as IKEA, can have significant power
when negotiating special tax regimes. Tax burdens can encourage location
strategies, where large corporations can use FDI to disperse their taxes to
countries that offer a more attractive rate. Assuming a monopoly model, as
illustrated by Porter (2017), higher taxes will have a large impact on the profitability
of internationalisation strategies, bringing more exporting than multinational
behaviour. Investing in foreign affiliations can often mean the multinational
is subject to international double taxation (De Mooij & Ederveen, 2003), both in their home-country
and the location of their foreign subsidiary. According to De Mooij &
Ederveen (2003), double taxation can prevent international business activity,
leading to the implementation of numerous legislation. For example, The Parent-Subsidiary
Directive, employed by the EU in order to reduce double taxation and encourage FDI.
Under this exemption system, income taxed in the host-country becomes exempt
from taxation in the home-country. Thus, a multinational firm’s profits are
only taxed by the host-country of their subsidiary. This enables large firms,
such as IKEA, to undertake FDI in ‘tax havens’ in order to minimise taxes. Tax havens
are countries that offer significantly low tax rates, found all over the world
(Figure 2), making them incredibly
attractive to foreign investors (Desai, Foley and Hines, 2004).
According to a report, published by the EU, IKEA has been funnelling billions
of euros from high taxation countries, such as the UK, into smaller
subsidiaries, decreasing the level of tax paid (Fortune, 2016). The ability of firms to create rivalry
amongst competition nations, emphasising their strategic interdependence, and
therefore initiate lower taxes, is a huge factor in FDI. Through manipulating
and undertaking strategic decisions, IKEA prevented paying over €1bn between 2009 and 2014 (The Guardian,
2016).

 

Figure
2: Chart to Show the Ten Most Popular Tax Havens (Source: The International
Consortium of Investigative Journalists (ICIJ))

 

However, recent analysis has shown
that tax incentives are not the most significant influence for FDI, implicating
no evident link between tax rates and a country’s investment climate (Teeffelen,
2017).
Similarly, numerous initiatives have been implemented to discourage this ‘tax
avoidance’ behaviour such as the EU Anti-Tax Avoidance Directive, making it
difficult for firms to gain strategic advantages through undertaking FDI in
low-tax countries (European Commision, 2016). This implies that lower
tax rates, incentivised through the theory of strategic interdependence between
firms and national policymakers, is not the most important factor behind IKEA’s
FDI.

Chen (2009) raises three prolific
factors that he deems carry more weight in the decision for FDI; the cost and
availability of labour, basic infrastructure and economic and political
stability. Through investing in a foreign country, IKEA has the potential to
tap into local resources, benefitting from cheaper land and human capital. In
2010, IKEA constructed a new factory in Orla, Eastern Poland. Numerous factors
were apparent in their motive behind investing including labour costs, local
resources and to enhance distribution logistics. According to (Ostaszewska, 2016), labour costs in
Eastern Poland are significantly low, with a national average of €800 per month. Eastern Poland also provides
IKEA with access to numerous forest resources, minimising costs through
proximity. Over 70% of the wood used in their factories originates from Belarus
located only 35km from the Orla factory (Ostaszewska, 2016). Similarly, in 1978, through reforming
and reopening its economy, China attracted a surplus of FDI through utilising
its supply of cheap labour (Ralph, 2012). Therefore, a
dominant factor behind IKEA’s FDI, is the drive to lower production costs
through utilising low-cost production factors in the host-country (Cushman,
1987).

However, low-cost labour can often
lead to low quality and efficiency. Although mainland China offers low-cost
labour to foreign investors, overall labour costs would seem to be high due to
low productivity and the lack of efficient management. Pfeffermann and
Madarassy (1992) found that for multinational corporations, a well-educated
pool of labour has become more attractive relative to low-cost labour. Since
manufacturing has become increasing automotive and capital intensive (Lall,
1998), the necessity for high-skilled labour is prevalent in IKEA’s decision
for a foreign affiliate.

In a monopolistic market, a key
economic factor for FDI can be attributed to the cost-minimisation theory. This
can be assessed through the Proximity-Concentration Trade-Off. As outlined by
Hill & Hult (2017), a significant determinant behind IKEA’s internationalisation
strategy is its desire to seek new markets. Brainard (1997) found that FDI was
more evident in cases where there were high transport costs and trade barriers
along with the ability to gain large economies of scale through foreign
production. In a study carried out by Helpman et al (2003), exploring the
decision factors of US firms seeking to serve markets abroad, it was evident
that firms would undertake FDI when the relative costs of transporting the
goods outweighed the costs of implementing foreign production facilities. Typically,
Swedish firms typically establish foreign affiliates to prevent high transportation
costs and trade barriers (Jordan & Vahlne, 1981). With wood as a main
component, IKEA faces high transportation costs. Through setting up production facilities
across Europe, IKEA can produce wooden boards in close proximity to their
furniture manufacturers. Locating its manufacturing plants near high population
regions such as Ukraine and Western Russia (Ostaszewska, 2016), IKEA has considerably minimised transportation
costs.

Furthermore, FDI can be depicted
through the level of output the firm intends to serve the market. The larger
the level of output, the more attractive FDI becomes (Porter, 2017). Melitz
(2003) further highlighted this by suggesting that the most productive firms
serve the market through FDI and the least productive via export. In 2004,
pricing and high duty tax rates posed immense challenges for IKEA when
exporting to China. In 2011, 33 million people visited China’s mainland stores
and with a revenue growth of 20%, China is one of IKEA’s fastest-growing
markets (VanderMey, 2011). With 24
current stores and the aim to open three more every year until 2020, moving
production facilities to China was the most cost-effective strategy for IKEA (IKEA, 2017). Dow (2000) further
highlights that low geographical distance will help multinational enterprises
to reduce the cost of operation and therefore price. Through setting up production
facilities in China, IKEA has prevented high transportation costs and export
taxes, enabling a reduction in its prices by more than 60%, with the
corporation seeking to further decline this through mass production and a cut
in supply chain costs (Chu, et al., 2013).

Incentives for FDI can be extremely
complex and hard to establish due to the involvement of strategic decisions. IKEA’s
motives for setting up foreign affiliations can be assessed through the
cost-minimisation theory. With the desire to serve markets on a large scale, in
order for IKEA to minimise costs, such as transportation costs, FDI is deemed
most efficient. However, the interdependence between governments and firms
signals as the most significant factor behind IKEA’s choice to undertake FDI.
Through establishing foreign affiliations in countries with low corporate tax
rates, using location strategies, has enabled IKEA to disperse their tax burden
to countries that offer a more attractive rate. Moreover, throughout the
analysis, it was apparent that both the theory of cost-minimisation and taxation
policies are not the only factors determining IKEA’s FDI, with basic
infrastructure and the cost and availability of labour having a significant
impact on their decisions. To further analyse IKEA’s decision to set-up foreign
affiliations, other economic theories should be assessed such as the incentive
to manipulate labour unions, decreasing both host-country and home-country
wages, as well as the impact of government policies such as grants and
subsidies.

 

 

 

 

 

 

 

 

 

 

 

References:

Chen, C., 2009. China’s
Integration with the Global Economy: WTO Accession, Foreign Direct Investment
and International Trade. 1 ed. China: Edward Elgar Publishing.

Chu, V., Girdhar, A. & Sood, R.,
2013. Business Today. Online Available at: http://www.businesstoday.in/magazine/lbs-case-study/how-ikea-adapted-its-strategies-to-expand-in-china/story/196322.html
Accessed 2 December 2017.

Coase, Ronald H., “The Nature
of the Firm”.Economica, N.S., Vol. 4, London, 1937, pp. 386–405. Repr.
In: George J. Stigler and Kenneth E. Boulding (Eds.), Readings in Price
Theory. Selected by a Committee of the American Economic Association,
Homewood, 1953, pp. 331–351.

Cushman,
D.O. (1987), “The effects of real wages and labour productivity on FDI”,
Southern Economic Journal, Vol. 54, July, pp. 174-85.

De Mooij, R. A. & Ederveen, S.,
2003. Taxation and Foreign Direct Investment: A Synthesis of Empirical Research.
International Tax and Public Finance, Volume 10, p. 673–693.

Desai, M., Foley, C. and Hines, J., 2004. Foreign direct
investment in a world of multiple taxes. Journal of Public Economics,
88(12), pp.2727-2744.

Dow, D., 2000. A Note on Psychological Distance and Export
Market Selection. Journal of International Marketing, 8(1),
pp.51-64.

Dunning, J. H., 2000. The Eclectic
Paradigm As An Envelope For Economic And Business Theories Of MNE Activity. International
Business Review, 9(2), pp. 163-190.

European Commision, 2016. The Anti
Tax Avoidance Directive. Online
Available at: https://ec.europa.eu/taxation_customs/business/company-tax/anti-tax-avoidance-package/anti-tax-avoidance-directive_en
Accessed 2 December 2017.

Fortune, 2016. Ikea Has Been Accused
of Avoiding 1 Billion Euros in Taxes. Online
Available at: http://fortune.com/2016/02/12/ikea-tax-avoidance/Accessed
3 December 2017.

Helpman, E., Yeaple, S. & Melitz,
M., 2003. Export Versus Fdi, Cambridge: National Bureau Of Economic
Research.

Hill, C. & Hult, T., 2017. International
Business: Competing in the Global Marketplace. Eleventh Edition ed. New
York: McGraw-Hill Education.

Hymer, Stephen H., The
International Operations of National Firms: A Study of Direct Foreign
Investment. M.I.T. Monographs in Economics, 14, Cambridge, Mass., 1976.

IKEA, 2015. Customer Service. Online
Available at: http://www.ikea.com/ms/en_JP/customer_service/faq/help/about_store/about_stores.html#10
Accessed 1 December 2017.

IKEA, 2017. IKEA 2017 by numbers. Online

Available at: http://www.ikea.com/gb/en/this-is-ikea/ikea-highlights/ikea-2017-by-numbers/
Accessed 2 December 2017.

Jordan,
J.L and I.E. Vahlne. “Domestic Employment Effects of Direct Investment
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Lingxiu, J., 2017. IKEA marketing
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1, pp. 2-51.

Loeb, W., 2012. Forbes. Online
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Accessed 2 December 2017.

Melitz, M., 2003. The Impact of Trade on Intra-Industry
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Mohdin, A., 2017. The five most important charts from the Panama Papers leaks. Online Quartz.
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Oman, C., 2000. Policy Competition for Foreign Direct
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Ostaszewska,
E., 2016. IKEA’s FDI in a Manufacturing Plant in Poland. Berlin Institute
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L., 2017. Lecture notes title ‘Economics
of Strategy 2: Public Policy & FDI’.
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