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Going Global in the 21st CenturyJEFFREY H. BERGSTRANDUNIVERSITY OF NOTRE DAMESOUTH BEND, INDIANA, USA

Spanish Unemployment Rate 2006-2017

Outline for Today’s LectureI. Context

(Macro level)

II. 5 Reasons for Going Global(Macro level and Firm level)

III. 5 Important Keys for Going Global(Firm level)

“Spain: Boom to Bust … and Back Again”“As you leave Valencia’s old town and head

east towards the port, you come face to face with two decades of Spanish economic history frozen in concrete, steel and glass.

“First come the gleaning spikes and waves of the City of Arts and Sciences … it blew a hole in the regional budget …. (see next slide)

“Next up is the Formula One racetrack … but abandoned after just five races….

“Now, at last, there are signs of life … boom and bust, recession and recovery –Valencia embodies the recent story of Spain like no other place.”

5 Reasons to “Go Global”:#1. Diversification

Even if two economies’ levels of Real GDP are positively correlated over time, there are gains to a firm from selling domestically and abroad.

Spain’s population, at 45 million, is only 0.7 of 1% of the world’s population.

I will use the term “Globally-Engaged” firm to denote either an exporter, an importer, or a multinational enterprise (MNE).

B. Shouldn’t there also be diversification for a geographically and economically large country – such as Spain – from simply selling in various regions of the economy?

Yes. However, the closer are two regions, the higher the positive correlation of their levels of economic activity. Distance matters!

This is the same principle upon which portfolio theory is founded.

ASIDE #1:By diversifying the set of markets that one sells to, the reduction in variance of sales reduces both the variance of firm profits but also the uncertainty surrounding them. Similarly, “globally-engaged” firms benefit from reductions in “trade-policy uncertainty.”

Hence, one of the important benefits of being a member of the EU is – not just lower trade and investment barriers in foreign markets – but also reduced uncertainty about such policies.

Empirical Evidence on the Benefits of Lower Trade-Policy Uncertainty

Empirical Evidence on the Benefits of Lower Trade-Policy UncertaintyKyle Handley and Nuno Limao (2016)The contribution to Portuguese growth from reducing trade-policy uncertainty of Portugal's accession to the European Community was substantive. The authors noted that Portuguese exports to Spain and to the EC in 1987 were 14.7 percent of Portugal's GDP. However, if trade-policy uncertainty had been held at its 1985 (pre-accession) level, Portuguese exports to Spain and to the EC in 1987 would have been only 11.5 percent of Portugal's GDP.

“Spain: Boom to Bust…and Back Again”

“Amid the debris of the downturn, however, some sense that the outlines of a new economic model for Spain are beginning to move into view….

“More important than the headline figure (of annual growth of 3% in 2015 and 2016) is the composition of Spanish output.”

“Spain: Boom to Bust…and Back Again”“In the years before the crisis, the volatile construction sector accounted for more than 10% of GDP. Today, that share has fallen to 5%.

“At the same time, Spanish exports of goods and services have risen from 25% of GDP to 33%. The country’s exports are also morediversified, with more companies in moresectors selling to more markets.” WHY?

5 Reasons to “Go Global”:

#1. Diversification

#2. Competitiveness (macro) (see next slides)

Spanish Unemployment Rate 2006-2017

ASIDE #2: What drives international trade flows?


Audience?


GRAVITY.

LO SIENTO !!!(Wrong Slide.)

GRAVITY EQUATION OF INTERNATIONAL TRADETradeij = GDPi GDPj [(pi tcij)/ Pj )-β

where β>1,tcij denotes “trade costs,”pi is the price of goods in i, and Pj is an index of the average of all prices for goods consumed in j.

β is a measure of “substitutability of goods.”

What explains “pi tcij” ?

10 most important macro-level factors:

1. Unit Labor Costs: wage rates/productivityk

2. Distance between countries i and j 3. Adjacency of countries i and j 4, Common language5. Common religions

Other factors lowering “pi tcij”:

6. Common colonial history7. Economic Integration Agreement8. Currency Union9. Government Effectiveness10. Good Regulatory Quality


“Away from hard economics, there are other signs of change in Spain. Recent election results show that voters are less tolerant of political corruption, and more reluctant to hand the country’s establishment parties the huge majorities they were accustomed to.”


#1. Diversification#2. Competitive (at macro level)

#3. Competitive (at micro level) (Characteristics of “Globally-Engaged” Firms)

Characteristics of Globally-Engaged Firms:

1. Larger (than firms not globally-engaged)2. More productive, in terms of value-added per worker3. Higher skill-level per worker (“skill-intensive”)4. More physical capital per worker (“capital-intensive”)

Because of these factors, globally-engaged firms pay higher average wages.

Does higher productivity “cause” firms to select into exporting, or…

…do firms that export becomemore productive?

There is considerable evidence that more productive firms become exporters, or MNEs. There is some evidence that exporting causes firms to become more productive, either through learning from exporting or having increased access to knowledge in other markets.


#1. Diversification#2. Competitive (at macro level)#3. Competitive (at micro level)

#4. Learning-by-Exporting (or doing FDI)

Learning by Exporting:I. The first step in exporting to a foreign market is “researching the foreign market thoroughly.” Such knowledge acquired improves best practices at home, improving productivity for serving the domestic market.

II. Distribution patterns are often host-country specific. Gaining knowledge of alternative methods of reaching the foreign consumer, business, or government introduces new knowledge and thinking at the firm’s headquarters at home.

III. Tapping into foreign markets can create access to new technologies.


#1. Diversification#2. Competitive (at macro level)#3. Competitive (at micro level)#4. Learning-by-Exporting (or doing FDI)

#5. Why Ship Wine to France? intra-Industry Trade

Why Ship Wine to France?

I. Intra-Industry Trade

II. Love of Variety

III. Economies of Scale in Production


“Today, regional (Valencia) ministers speak in low-key terms about the need to strengthen the industrial base, and ways to help small and medium-sized companies tap into foreign markets and access new technologies.”

5 “Keys to International Operations”Key #1: Research Foreign Markets Thoroughly-- Market research in a foreign country can be “primary” or “secondary.”-- “Primary” research entails management collecting data about the foreign market by interviewing potential customers, conducting surveys, and meeting industry representatives. -- The major benefit of conducting primary market research is that the surveys and interviews can be customized for the potential exporter. The major cost is considerable time and resources spent collecting the information.

-- Once a firm has developed experience exporting, the steep fixed costs of customized interviews and surveys can be spread among more markets as the volume of exports increases.-- Because primary research is quite costly, a firm just beginning to go global may instead choose “secondary” research, which is much less expensive and is often actually the best route for new exporters.-- Secondary research should include a broad macro survey of economic, political, and cultural factors influencing a foreign economy. Naturally, a heathy economy is an essential element to consider for a destination market.

5 “Keys to International Operations”Key #2: Export Indirectly at First-- The fixed costs of entering a foreign market to sell a product, especially a manufactured product that needs to be advertised and distributed, are not trivial. -- A Spanish company that is new to global business and averse to the risks and costs of setting up an extensive export effort should consider exporting “indirectly” at first.-- Indirect exporting employs an intermediary for locating buyers in a foreign market, coordinating shipping and distribution of the product, and ensuring payment.-- This method includes: export management companies, export merchants, and commission agents.

Export Management Companies:-- An export management company, sometimes called an export trading company, can represent several different Spanish exporters in various foreign markets, working on a commission, fee, or retainer plus commission. -- Often the export management firm specializes in a region or industry, developing expertise in establishing distribution channels in various countries and knowledge of the cultures and media network. -- One problem is using such a firm is that there is often a loss of control of maketing and servicing the product abroad and an inability to develop closer links to the buyers.

Export Merchants:

-- Export merchants instead purchase products from Spanish businesses and then sell the products overseas. Because products are purchased domestically, the firm loses all control over shipping, pricing, distributing, and servicing after the sale.

-- This approach is less expensive than employing an export management company. However, the firm is less involved in going global, and the long-term profit potential may be eroded by losing the proximity to potential customers.

Commission Agents:

-- Commission agents identify products for forieng businesses that are interested in importing them. Working on a commission, they have incentives to locate the lowest-cost producer of a good or service.

-- These agents also work for foreign governments.

5 “Keys to International Operations”Key #3: Once Established, Export Directly-- The advantages over exporting indirectly include more control over distribution, advertising, and long-term contacts and service.-- However, such advantages are costly, including the need for additional physical space and personnel to provide the resources devoted to research, customizing, marketing, shipping, insurance, accounting, and financing of the export operations.-- The use of sales representatives provides the greatest control over distribution and marketing, but is costly. An alternative to sales representatives is to contract with a foreign distributor.

5 “Keys to International Operations”Key #4: Exporting vs. Foreign Direct Investment“When you should produce here … and when you should produce there.”-- Going global does not necessarily entail export (or importing) a product of service to a foreign country. -- For an exporter, as the size of trade flows expand, transport and other trade costs across distances become burdensome.-- At some point, producing the product abroad IN the foreign market becomes cheaper, despite higher fixed costs of entry in the destination market.

-- Various methods of internationalizing a business abroad include licensing a particular technology, franchising a service, or arranging a joint venture.Licensing:-- The licensing of technology broadly describes the entering of a Spanish firm into a contract with a foreign business whereby a Spanish company’s patent, brad name, or copyright is sold to a foreign business in return for a royalty.-- The royalty generates income for the Spanish firm with it having to pa for customization, finding sales and distribution agents abroad, and shipping the product abroad.

Franchising:-- Franchising has been used in service industries to export a firm’s knowledge to a foreign country.

-- Brand names have considerable demand in foreign countries.

-- In franchising, the Spanish headquarters still support advertising, education, and financial aspects of the firm.

Joint Ventures:-- A joint venture between a Spanish and a foreign firm allows a Spanish firm to globalize its market without all the costs of exporting.-- The foreign partner contributes an understanding about the structure of the local economy, cyclical economic and business considerations, culture of the local economy, and tastes.-- If the costs of transporting the product are high, a joint venture can lower the costs of producing and serving a market abroad.

5 “Keys to International Operations”Key #5: Watch foreign governments … closely.-- A Spanish firm going abroad needs to be wary of the economic and exchange-rate policies of foreign governments.

-- An investment of time and resources into monitoring political and economic policies is a small insurance premium to pay to avoid large shocks.

-- The World Bank’s Doing Business is an excellent source (on the internet) of the regulations and risks of doing business in the vast number of countries around the world.

Gracias !

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