Question

The word “Investment” carries with it many definitions. In this course, it represents ‘Business Spending’----businesses spending money hiring workers to BUILD! The three areas of Business Spending can be broken down into: 1. new plant and equipment construction volume (new factory construction) 2. New residential construction volume and sales volume and 3. “new”----net additions to (or subtraction from) inventories. Inventories are often broken down into three areas: raw materials inventories, ‘work in process’ and finished product inventories (visualize new cars sitting in the dealership on Capitol Expressway). New plant and equipment inventories make up about two thirds of the total. Visualize a company owning and operating four factories that mass produce shoes: the yearly maintenance of the four factories can be called ‘replacement’ Investment. The construction of a new, 5th factory can be called ‘net’ Investment. One of the most, if not THE most high profile example of a new factory is the Tesla battery factory outside Sparks, Nevada. Let’s say a shoe company is mass producing shoes out of each of its four factories, each capable of producing 1 million pairs. Let’s say that the price per pair the firm sees (wholesale) is $30, and the cost per pair is $27. The price per pair is set by market conditions—the Demand Curve for the shoes. The firm earns a profit of $3 per pair for every pair produced, distributed and sold (the retailer will mark up the price to the customer). The driving force behind the firm’s decision to build “Factory #5”---the “green light”---is the idea that the firm enjoys a sales volume that is high, and rising, and expected to rise further in the future. The new factory will most likely result in a dramatic drop in the cost per pair owing to gains from new technology, yet the new extra shoes MUST BE SOLD to customers. The concept that the firm’s sales volume must be high and rising and expected to rise in the future can be restated as the firm’s ‘excess capacity’ must be low and dropping and expected to drop further in the future---in short, the firm’s sales volume, in theory, should be expected to ‘bust through’ or exceed the firm’s current capacity. This firm’s decision to build ‘Factory #5’ is perhaps the most important decision the firm will make in the next year or two. In theory, it is an “all or nothing” decision---let’s say the firm will spend $100 million to build the factory, or spend zero on this project. A ‘healthy’ firm that wants to expand may have two projects but may only obtain funding for one, or four projects and may only be able to obtain funding for two—owing to the fact that the supply of loanable funds, and equity funding, is finite and this firm will be competing with other firms for essentially the “same” funding. Once we make the decision to proceed---the ‘green light’---then we must line up FINANCING---where and how will we obtain $100million for our project, which will start on Jan 2 of next year and run until Dec 31 of that year? Profits, also known as retained earnings, are often the most important factor. Let’s say that we have earned $30 million in retained earnings, and we wish to borrow the other $70 million (let’s make it 75 million owing to possible cost overruns). We will apply for a loan from some financial institution, where the decision making body (we can call it a ‘loan committee’) is considering 10 loan applications, and will accept 5 and deny 5. We may have to ‘beat out’ a rival firm, who has their own great idea and their own grand plans for their own factory #5, but have $20 million saved in retained earnings and wish and need to borrow $80 million. The concept of a ‘shortage’ of funds suggests that we must appear a ‘stronger’ candidate for the financing than our rival. Sad but true. Let’s say we are in a position to “beat out” our rival for the loan money. We base our entire business model that the shoes mass produced by our new factory will cost, say, $27 per pair (we can revise this later) on certain assumptions about the cost of the land, labor, raw materials, plant and equipment needed to build the factory along with the projected cost of compliance involving government regulations (a big cost when it comes to building a house) and INTEREST PAYMENTS ON BORROWED MONEY! Let’s say that we are planning to borrow $70 million at an interest rate of 10% for yearly interest-only payments of $7 million per year. Let’s say that the interest rates on a loan like this in March of 1979 hovered in the range of 10%. From March 1979 to March 1980 the Federal Reserve pursued a ‘contractionary’ monetary policy that resulted in interest rates rising to roughly 20% ( about 18% for a home loan). The same loan committee that approved 5 and denied 5 of every ten loan applications will now approve 4 and deny 6. We saw one of the largest drops in new plant and equipment construction since the Great Depression. We could in theory raise money by issuing new equity securities (the ‘IPO’ is a prominent example) but this is less likely in an environment where liquidity is drying up, and interest rates are high or rising or both. It is not surprising that a drop in stock market values precedes a recession by a few months (the 2008-2009 recession is an example). Let’s assume that we have our own internal ‘green light’ and we have somehow obtained the needed financing---two hurdles overcome. Now, the great decision is: WHERE DO WE BUILD? Here, in the U.S.? Or in some other country? If we build on U.S. soil then the bulk of the construction costs will be counted as part of our Investment spending and part of the equation Total Spending=C+I+G+(X-M)

- Let’s say that we have a hypothetical firm operating four factories, each with the capacity to produce 1 million pairs of shoes. We have established that in order to build ‘Factory #5” it must 1. give itself the “green light”---sales volume must be high and rising and expected to rise further in the future---a necessary but not sufficient condition and 2. Raise the funding! Let’s say $100 million BEFORE WE BREAK GROUND ---our factory would be quite small --- Tesla is reported to be spending up to $5 billion for its battery plant outside Sparks. Factors involving raising the $100 million include: Profits, the higher the better, of course, but many firms will be required to spend money they do not have, in order to build factory #5, thus they must access financing through financial and capital markets, either through debt financing (borrowing the money) or equity financing (issuing new shares of equity securities). The fact that the supply of money in the financial and capital markets is FINITE is CENTRAL to the entire field of Macroeconomics! OKAY! We have the green light, and we have the financing! WHERE DO WE BUILD OUR FACTORY? In the U.S.? Or in another country? If we build in the U.S., then the ‘lion’s share’ of the $100 million will be part of the ‘Total Spending = C+I+G+X-M equation. If we build in another country, then very little of the $100 million will be spent on U.S. products and services, at least in theory. REASONS TO BUILD IN ANOTHER COUNTRY: 1. LABOR COSTS! A factory worker in the U.S. may earn over $20 and hour in wages, and cost over $28 in hourly costs to her employer—on average---compared to perhaps a wage as low as $2 an hour in another country. The disparity in wages in the U.S. is simply incredible: let’s say a worker may earn $7.25 an hour (the federal minimum wage in the U.S.----it has not risen in several years) in a chicken processing plant in Arkansas (most likely this worker came here from another country, either legally or ‘extralegally’---our economy RUNS on these workers!!) while a skilled worker may earn over $100,000 a year (no wonder the students in the Automotive classes get here earlier than I do---7:20am). The difference in a hypothetical U.S. worker’s hourly wage and her hourly cost to her employer ----that $8 (in theory) would consist of the employer’s share of FICA---remember FICA???—along with unemployment insurance, disablility &worker’s compensation benefits, possible medical benefits, 401k matching and pension benefits (not in most gig economy jobs) and other costs the employer bears but the employee does not see in her take home pay. The huge disparity (in theory) between labor costs in the U.S. compared to labor costs in another country are greatly diminished by the VERY likely fact that Factory #5 uses MUCH less labor---employs fewer workers than Factory #4. It is possible that Factory #5 uses fewer than half the workers in factory #4. If we did a walk-through of Factory #1, we would not believe that is was owned and operated by the same company. Toyota shut down its NUMMI plant in Fremont, while opening a new plant in Texas. We can estimate that the labor costs were much lower in the Texas facility. 2. TAX POLICY here in the U.S. compared to another country: our government entities---federal, state and local----may offer tax incentives for our firm to build Factory #5 in the U.S. (or the state of Nevada, where it is reported that Tesla may be receiving a ‘tax credit’ of perhaps 10% from the state). These possible tax incentives may be called an “Investment Tax Credit”--- I would call them a “Factory #5 construction tax credit”. Let’s not forget: the underlying reason to build the factory must be in place ---we must sell this steady stream of new extra shoes or cars or MRI machines—but if our price per pair is $30 and our cost per pair (without the tax incentives) is $27 and our projected profit is $3 per pair (in theory) then a 10% tax credit could raise our profits greatly. The issue: SOME OTHER COUNTRY also has a government, and it is offering its own tax incentives for us to build on THEIR soil. It can become a ‘bidding war’. Why does every country want our factory? JOBS! More on that later…..3. GOVERNMENT REGULATIONS (G REGS) HERE vs. THERE: every government of every country has established a framework of laws and regulations (regs) to protect its people. Sometimes a firm – like us—may take actions that are immoral and illegal. G REGS are put in place to address these actions, and in a perfect world, prevent them from happening in the first place. What can a firm ‘do wrong’ --- and what GOVERNMENT REGULATORY AGENCIES in the U.S. (as well as the legal system) exist to address and prevent these ‘wrongs’? 1. ‘TOO MUCH’ POLLUTION: if a firm pollutes the environment beyond a certain level, the legal system as well as the EPA (both federal and state---our state has the CARB and many other agencies) may step in to fine or enjoin the firm in the U.S.---thus raising our cost of doing business. What if this other country competing for our factory has a more relaxed set of pollution control laws and regs? 2. UNSAFE WORKING CONDITIONS: We have a pretty robust legal system and worker’s comp and worker’s disability system in the U.S.---for some workers, not all—compared to many other countries. We have the OSHA---both on the federal and state level—which can raise the cost of doing business---building the factory, then operating the factory once it is up and running---compared to another country 3. UNSAFE PRODUCTS: in the U.S. we have dozens of regulatory agencies, including the FDA, NHTSA, FAA, CPSC, the Dept. of Agriculture and DOZENS of other agencies to address, and hopefully prevent, unsafe products from being produced, distributed and sold in the U.S. 4. DISCRIMINATION: The EEOC (the Dept. of Labor) ---both federal and state---and our legal system act to address and try to prevent discrimination by employers against women, older workers, and other groups. The discrimination lawsuit that female employees filed against Walmart in the U.S. NEVER WOULD HAVE OCCURRED in many other countries 5. ABUSES OF MARKET POWER: The U.S. has a series of ‘Antitrust’ laws, created about 110 years ago and built on since, that try to address and prevent ‘abuses of market power’ by firms doing business in the U.S.---the relevant agencies include the Antitrust Division of the Justice Dept. and the Attorneys General of all 50 states (many are going after Google right now) as well as the FTC. 6. INACCURATE REPORTING OF PROFITS AND LOSSES---Enron being the classic example---when a firm doing business in the U.S. violates these laws, it may be prosecuted by the Dept. of Justice, the SEC, the IRS, and many other agencies. There are many other misdeeds a firm –maybe our firm---could perform, and other U.S. and state and local regulatory agencies that may prosecute us and raise our costs of doing business. What if this other country’s government – competing for our business - simply has a more…’relaxed’….. set of regulations? Wow! Some other country may offer cheaper labor, a more attractive tax package, a more ‘friendly’ set of regulations… why would our firm build factory #5 on U.S. soil? I believe that recent events help explain this set of concepts…

- WHY BUILD FACTORY #5 on U.S. soil? I mean, labor is cheaper in another country, Government Regulations may be more relaxed and cheaper to comply with, and the tax incentives offered by another country may be more attractive… so why build here? Many reasons, starting with: 1. the idea that the U.S. economy, with over $20 Trillion in annual Total Spending on all goods and services, is still the largest market in the world. US. HOUSEHOLDS, GOVERNMENTS and BUSINESSES buy every conceivable product and service. If our firm builds Factory #5 in another country, then we must incur 2.TRANSPORTATION COSTS and burdens that we may not be able to forsee. We have a pretty good example of this concept playing out RIGHT NOW. EVEN IF we build Factory #5 fifty feet south, or north, of our border, we must move our product across the border into the U.S. Our government (and every government I have ever read about) maintains the right to STOP AND INSPECT any and all cargo—this can take two minutes, two hours, two days, two weeks, two months. The same concept applies to people, as evidenced by the tragedy at our southern border. I have a friend who had a Y2K job up in Canada. She got off the plane in Toronto and she was ushered into a windowless room and ‘questioned’ for hours--- AND I THOUGHT CANADA WAS AN ALLY!!! If we must transport our products across the U.S. border by plane, truck, auto, ship, rail we are vulnerable to any FUTURE RISE in transportation costs—anticipated or not. Energy costs. Shipping costs. Fees at the Port of Oakland or Long Beach. Let’s say we plan to sell our product to buyers in the U.S. for the entire 20 year life of our factory. Do we ‘feel lucky’ for the next 20 years? Yes, yes, supply chains are very VERY interdependent----and, as we now know, fragile, at least in theory. What if a second terrorist attack similar in scale to 9\11 were to occur? Our government could, in theory, ENFORCE EXISTING LAWS AND PROTOCALS to “slow down” the stop and inspection process. The U.S. has thermal imaging technology whereby a container or truck is brought in to a bay and “Xray”d if you will…. If this technology were to be employed more vigorously, our product would not make it to the shelves, or to the Amazon “fulfillment center” in a timely basis, cutting in to those profit margins that we had anticipated. Do you feel lucky? MANY firms have built Factory #5 overseas… and then built their next factory, Factory #6, on U.S. soil---and they weren’t being altruistic or patriotic in their decision. Profit maximization is the driving force behind every decision a firm makes, including where to build Factory #5. 3. TRADE BARRIERS: TARIFFS AND QUOTAS! Again, the present time is instructive. As many of you know, the President of the U.S. can unilaterally, without approval by Congress, impose new, extra tariffs on products coming in to the U.S. The only brake on a reckless President is impeachment---and CONVICTION, as we know too well. Do you feel lucky? For the next 20 years? (a tariff is a tax on products coming in to the U.S.) Raising tariffs is widely seen as bad policy: the price of the imports rises for the U.S. consumer, cutting into her purchasing power, and our trading partner RETAILIATES by raising THEIR tariffs on OUR EXPORTS, thus costing U.S. jobs. Higher inflation AND higher unemployment, hurting two of the five major goals of Macro policy 4. “NON-QUANTIFIABLE” forces: let’s say we build factory #5 7,000 miles away from our headquarters for all the reasons we discussed earlier. It is up and running on Jan2. In Feb, the rains come---roads are washed out. Raw materials cannot arrive. No profits. In fact, we still have to make the mortgage payments on the Factory---our newest, best hope of survival. In March there is a LONG dockworker’s strike. A strike by dockworkers can happen here, but very rarely, and they not last very long. Again, an interruption of that steady flow of new, extra products. In May, the electricity is out. In June, the natural gas distribution is shut down. Again, it can happen here, but when it does it is a BIG DEAL, and, in the U.S., over 98% of the time, the lights are on and you can heat your home or office. And run your factory. The political pressure on PG&E has been sufficient to ensure somewhat reliable power---compared to some rival nations. In July, there is political upheaval leading to a GENERAL strike---almost NO ONE is working. No profits for us. Extreme case: there is a revolution---it happens—and our factory is destroyed, or worse, taken over by ‘the people’ and it becomes a “people’s” factory---but we still owe Bank of America the monthly mortgage payments---yes, insurance is possible---but we have lost our capacity in the meantime-----we have orders that WE CANNOT FILL---a rival firm will fill them. We lose market share. We complain to our government, and they tell us ‘WHY DID YOU BUILD FACTORY #5 in THAT country?” The biggest mistake we can ever make. Factory #5 was our future. The U.S. may very well be the most profitable place to build factory #5.

following the lectures to answer all of the questions.

1. Please list and discuss at least four government regulations that may be stricter for a firm, and more costly to comply with, in the U.S. as compared to other countries.

2. What "hurdles" must a firm overcome in order to build a factory in the next 12 to 24 months?

3. What forces may influence a firm to build its next factory in another country? Which one force may be the most important, in your opinion? Why?

4. What forces may influence a firm to build its next factory on U.S. soil? Which one force may be the most important, in your opinion? Why?

Answer 1

Answer:1

Lists Government regulations that may be stricter for a firm, and more costly to comply with, in the U.S. as compared to other countries.:-

There has been numberous Government regulations in The U.S which can be said to be more stricter when compared with the regulations of other countries for the Business .U.S Like every country has framed rules regulation to protect its peoples from any illegal and immoral activities .

Earning of Factory workers $ 7.25 As decided By Federal US Minimum and in U.S Per hour paid over $20 and hour in wages, and cost over $28 in hourly costs to her employer. Same is low $ 2 in other country.

1. ‘TOO MUCH’ POLLUTION May cause Enjoin operation: if a firm pollutes the environment beyond a certain level, the legal system as well as the EPA enjoin the firm in the U.S.---thus raising our cost of doing business

2. UNSAFE WORKING CONDITIONS: We have a pretty robust legal system and worker’s comp and worker’s disability system in the U.S.---for some workers, not all—compared to many other countries. We have the OSHA---both on the federal and state level—which can raise the cost of doing business---building the factory, then operating the factory once it is up and running---compared to another country

3. UNSAFE PRODUCTS: in the U.S. dozens of regulatory agencies, including the FDA, NHTSA, FAA, CPSC, the Dept. of Agriculture and DOZENS of other agencies to address, and hopefully prevent, unsafe products from being produced, distributed and sold in the U.S.

4. DISCRIMINATION: The EEOC (the Dept. of Labor) ---both federal and state---and our legal system act to address and try to prevent discrimination by employers against women, older workers, and other groups.

5. ABUSES OF MARKET POWER: The U.S. has a series of ‘Antitrust’ laws, created about 110 years ago and built on since, that try to address and prevent ‘abuses of market power’ by firms doing business in the U.S.

6. INACCURATE REPORTING OF PROFITS AND LOSSES---Enron being the classic example---when a firm doing business in the U.S. violates these laws, it may be prosecuted by the Dept. of Justice, the SEC, the IRS, and many other agencies.

Answer:2

Hurdles" must a firm overcome in order to build a factory in the next 12 to 24 months :-

1. Green Light

2. Financial

3. Interest on Borrowed capital

Above are hurdles which should be overcome

Answr;3

forces may influence a firm to build its next factory in another country:-

1. Labour : labor is cheaper in another country

2. Government regulation :more relaxed and cheaper to comply with in other country

3. tax incentives offered :-by another country may be more attractive in other country

Answer:4

forces may influence a firm to build its next factory on U.S. soil

1. The HiGH spending in U.S. economy :,

with over $20 Trillion in annual Total Spending on all goods and services, is still the largest market in the world. US. HOUSEHOLDS, GOVERNMENTS and BUSINESSES buy every conceivable product and service. If our firm builds Factory #5 in another country, then we must incur

2.TRANSPORTATION COSTS :

Our government (and every government I have ever read about) maintains the right to STOP AND INSPECT any and all cargo—this can take two minutes, two hours, two days, two weeks, two months. The same concept applies to people, as evidenced by the tragedy at our southern border. What if a second terrorist attack similar in scale to 9\11 were to occur? Our government could, in theory, ENFORCE EXISTING LAWS AND PROTOCALS to “slow down” the stop and inspection process. The U.S. has thermal imaging technology whereby a container or truck is brought in to a bay and “Xray”d if you will…. If this technology were to be employed more vigorously, our product would not make it to the shelves, or to the Amazon “fulfillment center” in a timely basis, cutting in to those profit margins that we had anticipated.

3. TRADE BARRIERS: TARIFFS AND QUOTAS!

The President of the U.S. can unilaterally, without approval by Congress, impose new, extra tariffs on products coming in to the U.S.

4. “NON-QUANTIFIABLE” forces:

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