Question

1. Explain how trade costs and market size (of a host country) affect vertical FDI and Horizontal FDI.

Answer 1

Export-platform FDI is motivated by a desire to export instead of serving the local Marketplace. Vertical FDI is an FDI export site where the exports are returned to the home Marketplace. There is however a increasing trend towards the FDI export site, where the Exports are destined for third markets. This trend may be helped by the rise of trade blocks with low internal trade barriers but higher external barriers. Establishing multinationals Manufacturing plants inside a trading block and using the plant to supply the entire region. To the degree that the host country is small compared to the overall size of the trading block, the vast majority of production would be exported to other countries. Motta and Norman (1996) found that this approach increased market access to export network FDI within a trade blockleads. As an added advantage, as FDI in the block is more attractive to outside firms as firms are better able to access the majority of markets inside the block by exporting from one factory, the subsidies needed to attract firms to the block would be re-established. Rather than say Even the market size of a possible host country is now perceived by corporations to be larger, more global A market easily accessible from the region. Since trade blocks also build on A national basis to reduce artificial barriers to trade (such as tariffs), and natural tradeBarriers (the costs of transportation) tend to go hand in hand. Kumar (1998) stressed the need to make a distinction between FDI export platforms Oriented towards home market versus third-country oriented. FDI to Exports back to the home market take advantage of cheaper manufacturing factors And there, only the trade costs between the host nation and the home country matter.

Bigger size of the host market Country, smaller fixed costs at plant level (smaller economies of plant scale), and larger fixed costs and Cost of trade is more conducive to horizontal FDI. Generic vertical FDI models include the option of location of output to Costs are minimised. Headquarters facilities are based at home; manufacture of the
Good may be located in the home country, or separate and located Outside. In the host country it is assumed that production costs are lower than at home. The trade-off therefore lies between the lower costs of exporting abroad and the need to pay Costs of trade to return the goods home. FDI happens when the cost savings resulting from production Outside, the costs of trade are greater than those incurred. Lower cost of trade would stimulate Vertical FDI but disincentive to horizontal FDI. As the cost of exchange decreases, vertical FDI for Smaller price differentials. In a simple setup, where there is only one unit of labor If the wage gap is required to produce the good in either region, vertical FDI occurs It's bigger across countries than the cost of trade. As FDI is also called vertical Global outsourcing / offshoring (see separate entry), cost savings for production Minus the costs of trade may be considered offshoring benefit.