firms, location and distance chapter 6. distance in economics the relevance of transportation costs...
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Firms, Location and Distance
Chapter 6
Distance in economics The relevance of transportation costs (Table 6.1)
CIF (cost, insurance, freight) FOB (free on board)
Empirical evidence (Hummels, 1999) Shipping costs are higher in
countries located further away from major markets, and landlocked countries.
Transport costs have not declined uniformly over time (costs of distant travel have declined relative to proximate travel).
Also see Box 6.1.
Table 6.1 Regional trade pattern of Europe; percent of total, 1860-2009
Export to: Europe United States China Japan Rest of world
1860 1910 1999
67.5 67.9 69.1
9.1 7.6 8.5
0.9
1.6
23.4 24.5 19.9
2004 68.5 7.8 1.6 1.4 20.7 2009 66.7 6.2 2.5 1.1 23.5
Import from: Europe United States China Japan ROW
1860 1910 1999
61 60
66.2
14.3 14 7.5
2.4
3.4
24.7 26
20.4 2004 66.0 5.3 4.3 2.5 22.0 2009 63.9 4.8 6.5 1.7 23.1
Source: Baldwin and Martin (1999) for 1860 and 1910 data, other data from Eurostat; China excludes Hong Kong.
Figure 6.1 Ad valorem trade costs by exporting country, 2008 (%)
Ad valorem trade costs (%) and per cent rank by exporting country, 2008
0
5
10
15
20
0 20 40 60 80 100rank
trad
e co
sts
Ireland
average
UKGermany
Netherlands USA
China
Burkina Faso
Brazil
Australia
Philippines
Papua New Guinea
Source: based on data for 134 countries from Sourcin and Pomfret (2012).
Figure 6.2 Container port traffic; mn TEU (20-foot equivalent units), 2000-2010
Container port traffic; million TEU 20-foot equivalent units, 2000-2010
130
41
China
42United States
29Singapore
18Japan15Germany
0
20
40
60
80
100
120
140
2000 2002 2004 2006 2008 2010
Source: world bank development indicators online
Table 6.2 The world’s largest container ports; mn TEU, 1989 and 2009
1989 2009 1 Hong Kong 4.5 Singapore 25.8 2 Singapore 4.4 Shanghai (China) 25.0 3 Rotterdam (Netherlands) 3.9 Hong Kong 20.9 4 Kaohsiung (Taiwan) 3.4 Shenzhen (China) 18.2 5 Kobe (Japan) 2.5 Busan (South Korea) 11.9 6 Busan (South Korea) 2.2 Guangzhou (China) 11.2 7 Los Angeles (USA) 2.1 Dubai (Un Arab Emirates) 11.1 8 New York (USA) 2.0 Ningbo (China) 10.5 9 Keelung (Taiwan) 1.8 Qingdao (China) 10.2 10 Hamburg (Germany) 1.7 Rotterdam (Netherlands) 9.7 11 Long Beach (USA) 1.5 Tianjin (China) 8.7 12 Yokohama (Japan) 1.5 Kaohsiung (Taiwan) 8.5 13 Antwerp (Belgium) 1.5 Antwerp (Belgium) 7.3 14 Tokyo (Japan) 1.4 Port Klang (Malaysia) 7.3 15 Felixstowe (Britain) 1.4 Hamburg (Germany) 7.0 16 San Juan (Puerto Rico) 1.3 Los Angeles (USA) 6.7 17 Bremen (Germany) 1.2 Tanjung Pelepas (Malaysia) 6.0 18 Oakland (USA) 1.1 Long Beach (USA) 5.0 19 Seattle (USA) 1.0 Xiamen (China) 4.6 20 Manila (Philippines) 0.9 Laem Chabang (Thailand) 4.6 Source: The Economist Aug 24, 2010
Figure 6.3 Developments in world air transport freight; mn ton-km, 1975-2010
World air transport freight
0
50,000
100,000
150,000
200,000
1975 1980 1985 1990 1995 2000 2005 2010year
mill
ion
ton-
km
Source: world bank development indicators online
Firm in Homeserve foreign markets / source from abroad?
Stay domestic
Export
Export or local production?
Import or local production?
ImportMultinational activity:
horizontalMultinational activity:
vertical
no
yes, serve foreign market
yes, source from abroad
exportlocal
productionimportlocal
production
Figure 6.4 Home firm decision tree
Simplifying assumptions1. Firms can locate production in two (identical) countries.
2. Production uses only one input.
3. MCs in terms of labor are constant.
4. There are firm-specific fixed costs (F); related to knowledge capital. These costs are only imposed once.
5. Setting up a plant gives rise to plant-specific fixed costs (P).
6. Transportation costs (in terms of labor) are t per unit exported.
7. Markets are segmented (i.e., no risk of arbitrage).
8. Headquarters also use resources, which are covered by firm-specific fixed costs (F).
A
0 x
p
D
MR
AC
MCh
B
0 x
p
D
MR
MCh
MCh + t
Home Foreign
A
0 x
p
D
MR
AC
MCh
B
0 x
p
D
MR
MCh
MCh + t
Home Foreign
Figure 6.5 Profits in the Home and Foreign market: national exporting firm
C
0 x
p
D
MR
AC; F + P
MCh
D
0 x
p
D
MRMCf
Home Foreign
AC; P
C
0 x
p
D
MR
AC; F + P
MCh
D
0 x
p
D
MRMCf
Home Foreign
AC; P
Figure 6.6 Going multinational: the horizontal case
E
0 x
p
D
MR
AC; F
MCf
G
0 x
p
D
MRMCf
Home Foreign
AC; PMCf + t
E
0 x
p
D
MR
AC; F
MCf
G
0 x
p
D
MRMCf
Home Foreign
AC; PMCf + t
Figure 6.7 Going multinational: the vertical case
Hybrid cases
• Combination of market seeking (horizontal) and efficiency and/or natural resource seeking (vertical) multinational activity.– Export platform multinational activity– Strategic asset seeking multinational activity
The Gravity Model of International Trade
Link between distance and trade Introduces a spatial or geographical element. If the two countries are large and are close
to each other then bilateral trade (between them) will be large.
Is geography destiny?1. The role of infrastructure and technology.
2. No center of production remains a center forever.
Liability of foreignness and multiple types of distance
Geographic distance Cultural distance (also see box 6.3) Economic distance Institutional/legal distance
Figure 6.8 Geographic distance and foreign sales of US multinationals
Asia
All countries
Europe & Africa
Americas
Fo
reig
n s
ale
s o
f US
mu
ltin
atio
nals
(20
08)
0 5000 10000 15000 20000Geographic distance (kilometers)
Figure 6.9 Cultural distance and foreign sales of US multinationals
Canada
New Zealand
China
Russia
Fo
reig
n s
ale
s o
f US
mu
ltin
atio
nals
(20
08)
HighLowCultural distance
Figure 6.10 Institutional quality and foreign sales of US multinationals
Venezuela
Nigeria
Russia
China
Switzerland
Sweden
Finland
Fo
reig
n s
ale
s o
f US
mu
ltin
atio
nals
(20
08)
Low HighInstitutional quality of host country
Figure 6.11 Liability of foreignness for a horizontal multinational
0
10
0 5
a
bp0
c
de
f
demand
marginal revenue
marginal cost
average cost local
average cost multinational
cost of doing business abroad (lost profit)
pric
e
outputq0
Firm strategy, structure, and rivalry
Related and supporting industries
Demand conditions
Factor conditions
Figure 6.12 Porter’s diamond model
Dunning’s Ownership-Location-Internalization (OLI) Model
Dunning’s observation (in the 1950s) that
the US subsidiaries in the UK had higher
productivity relative to UK competitors.– Was the higher productivity due to higher efficiency by
US managers regardless of location (ownership-specific effect) or due to superior resources of the US economy (importance of location).
– But why do firms exploit their ownership-specific effect internally (internalization aspect, keeping foreign activities in house) instead of keeping these activities at arm’s length?
Outsourcing
3 main advantages of sub-contracting1. Forgoing the plant specific fixed costs.2. Cutting storage costs.3. Access to experience and knowledge of the
foreign firm.Main disadvantage Increased economic uncertainty due to
dependence on the foreign partner and political and economic conditions in the partner’s country
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