Question

What are the differences between vertical integration and vertical FDI flows?

( In relate to Krugman's International Economics Theory and Policy )

Answer 1

Vertical Integration: The company owns or controls some part of the production process of the goods it sell in the market. In other words, the Multinational might buy some parts of production or sales process, like a retail location or a sales office. It does so in order to reduce costs or directly control its production process.

Vertical FDI flows: Here, the production is broken up, and parts of processes are transferred in different locations. Investing in such affiliates in called vertical FDI flows.

Differences:

• In vertical integration, MNC buys and controls the affiliate completely while in vertical FDI, MNC may acquire some assets in the affiliate or build it, it may not buy it and does not completely control it.
• Vertical integration can be between companies of developed nations while vertical FDI flows from developed to developing countries, mainly to take advantages of comparative advantage.
• Decisions regarding vertical integration involves reducing production costs through reduction in transportation cost, transaction costs and marketing costs. Cost advantages due to differences in prices of factors of production is the main reason for undertaking DI decision.
• Vertical integration can happen both intra-country and inter-country while vertical FDI flows across borders.