Undergraduate investments made by multinational corporations in foreign countries,

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Last updated: June 21, 2019

Undergraduate Coursework hand-in sheetSchool ofManagement – Undergraduate Coursework hand-in sheet Student name(s) %   % Saiskia Sales                       For group work –  individual %contributions need to be stated onlywhere they are not equal. Department (e.

g. Management):                     Management Programme and Year of Study:                         BBA3 Name of lecturer:                                                 Lynda Porter Unit title and code  (eg MN20010):                   MN20027 Number of pages in assignment:                        5 Declaration  I/we certify that I/we have read and understoodthe entry in the relevant Student Handbook for the School of Management onCheating and Plagiarism and that all material in this assignment is my/our ownwork, except where I/we have indicated with appropriate references. I/we agreethat, in line with Regulation 15.3(e), if requested I/we will submit anelectronic copy of this work for submission to a Plagiarism Detection Servicefor quality assurance purposes.

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I/we also confirm that the percentage allocationof work is as shown above. Student Signature(s)                          If assessment is group based, allmembers of the group must sign this form.When tohand inYou should aim to hand your work inbefore the deadline given by your lecturer/ tutor.  The University guidelines on penalties forlate submission are as follows:Any assessment submitted late without anagreed extension, will receive a maximum mark of 40%.  Any assessment submitted more than 5 workingdays late without an agreed extension will receive a mark of zero.How to handinThis form is available electronically and can bepasted in to the front page of your assignment. If you are including this as a hard copy this sheet must be stapled tothe cover of your assignment.

You mustkeep a copy of your course-work.When handing work into the School of ManagementReception you should sign the unit signing-in sheet and pass the sheet and yourcourse-work to a member of the Office staff for checking. Choosea firm that owns production facilities (i.

e. hasundertaken FDI) in one or more foreign countries. Explain and criticallyevaluate the relative importance of the economic factors that affected thischoice.   Foreign Direct Investment (FDI) isoften referred to as investments made by multinational corporations in foreign countries,such as affiliations and subsidiaries (De Mooij & Ederveen, 2003).

In order to remaincompetitive amongst rivals, firms facilitate a number of economic strategies togain market advantages. Numerous literature has explored the phenomenon of FDI,developing theories to understand the motivation behind internationalproduction (Rugman, 1980). Several studies havepresented ideologies based on the general theory of internalisation; where FDIis undertaken due to imperfections in the market. The theory of internalisationwas first advanced by Coase (1937), domestically, and later developed by Hymer(1976) in an international dimension. Additionally, Dunning (2000) presented threeconditions that must be met in order for a multinational, which seeks to maximiseprofit, to undertake FDI: Ownership, Location and Internalisation. Modernliterature advocates alternative economic theories determining FDI such ascost-minimisation and public policy (Porter, 2017).

Founded in 1943, IKEA’sunparalleled global strategy has enabled it to become the world’s largestfurniture retailer (Loeb, 2012).With over 312 stores in 38 countries, IKEA has the capacity to reach millions worldwidewith a staggering 936 million in-store visits in 2017 (IKEA, 2017).While most of its operations, design and management are run in Sweden, numerousmanufacturing aspects have been outsourced to China and other Asian countries (Loeb, 2012). Through ensuringeach opportunity to enter a foreign market is achieved and continuouslyenhancing enterprise internationalisation, IKEA has remained competitive (Lingxiu, 2017). Through analysingspecific production locations, such as Poland and China, both cost-minimisationand public policies were key factors in their decision to undertake FDI. Interdependences between governmentsand firms are significant in understanding FDI due to the ability ofmultinationals to strategically manipulate the behaviour of nationalpolicymakers. FDI is extremely attractive to governments, as not only does itincrease domestic income through taxation but spill over effects can lead totechnological enhancements and a more advanced labour force (Porter, 2017). Inmodern-day economics, FDI is increasingly flexible, where firms have the abilityto locate in numerous countries, incentivising governments to create the mosttax favourable environment.

According to Teeffelen (2017), government incentiveactivities such as lower taxes have considerably increased since the mid-1980s,illustrated in Figure 1.     Figure1: Global Corporate Tax Rate 1980-2015 (Source: Eurodad Calculations based onIMF Data) In a recent study by Oman (2000), itwas prevalent that large foreign companies, such as IKEA, can have significant powerwhen negotiating special tax regimes. Tax burdens can encourage locationstrategies, where large corporations can use FDI to disperse their taxes tocountries that offer a more attractive rate. Assuming a monopoly model, asillustrated by Porter (2017), higher taxes will have a large impact on the profitabilityof internationalisation strategies, bringing more exporting than multinationalbehaviour. Investing in foreign affiliations can often mean the multinationalis subject to international double taxation (De Mooij & Ederveen, 2003), both in their home-countryand the location of their foreign subsidiary. According to De Mooij &Ederveen (2003), double taxation can prevent international business activity,leading to the implementation of numerous legislation. For example, The Parent-SubsidiaryDirective, employed by the EU in order to reduce double taxation and encourage FDI.

Under this exemption system, income taxed in the host-country becomes exemptfrom taxation in the home-country. Thus, a multinational firm’s profits areonly taxed by the host-country of their subsidiary. This enables large firms,such as IKEA, to undertake FDI in ‘tax havens’ in order to minimise taxes. Tax havensare countries that offer significantly low tax rates, found all over the world(Figure 2), making them incrediblyattractive to foreign investors (Desai, Foley and Hines, 2004).According to a report, published by the EU, IKEA has been funnelling billionsof euros from high taxation countries, such as the UK, into smallersubsidiaries, decreasing the level of tax paid (Fortune, 2016). The ability of firms to create rivalryamongst competition nations, emphasising their strategic interdependence, andtherefore initiate lower taxes, is a huge factor in FDI. Through manipulatingand undertaking strategic decisions, IKEA prevented paying over €1bn between 2009 and 2014 (The Guardian, 2016).

  Figure2: Chart to Show the Ten Most Popular Tax Havens (Source: The InternationalConsortium of Investigative Journalists (ICIJ)) However, recent analysis has shownthat tax incentives are not the most significant influence for FDI, implicatingno evident link between tax rates and a country’s investment climate (Teeffelen, 2017).Similarly, numerous initiatives have been implemented to discourage this ‘taxavoidance’ behaviour such as the EU Anti-Tax Avoidance Directive, making itdifficult for firms to gain strategic advantages through undertaking FDI inlow-tax countries (European Commision, 2016). This implies that lowertax rates, incentivised through the theory of strategic interdependence betweenfirms and national policymakers, is not the most important factor behind IKEA’sFDI. Chen (2009) raises three prolificfactors that he deems carry more weight in the decision for FDI; the cost andavailability of labour, basic infrastructure and economic and politicalstability. Through investing in a foreign country, IKEA has the potential totap into local resources, benefitting from cheaper land and human capital.

In2010, IKEA constructed a new factory in Orla, Eastern Poland. Numerous factorswere apparent in their motive behind investing including labour costs, localresources and to enhance distribution logistics. According to (Ostaszewska, 2016), labour costs inEastern Poland are significantly low, with a national average of €800 per month. Eastern Poland also providesIKEA with access to numerous forest resources, minimising costs throughproximity. Over 70% of the wood used in their factories originates from Belaruslocated only 35km from the Orla factory (Ostaszewska, 2016). Similarly, in 1978, through reformingand reopening its economy, China attracted a surplus of FDI through utilisingits supply of cheap labour (Ralph, 2012). Therefore, adominant factor behind IKEA’s FDI, is the drive to lower production coststhrough utilising low-cost production factors in the host-country (Cushman,1987).

However, low-cost labour can oftenlead to low quality and efficiency. Although mainland China offers low-costlabour to foreign investors, overall labour costs would seem to be high due tolow productivity and the lack of efficient management. Pfeffermann andMadarassy (1992) found that for multinational corporations, a well-educatedpool of labour has become more attractive relative to low-cost labour. Sincemanufacturing has become increasing automotive and capital intensive (Lall,1998), the necessity for high-skilled labour is prevalent in IKEA’s decisionfor a foreign affiliate. In a monopolistic market, a keyeconomic factor for FDI can be attributed to the cost-minimisation theory. Thiscan be assessed through the Proximity-Concentration Trade-Off. As outlined byHill & Hult (2017), a significant determinant behind IKEA’s internationalisationstrategy is its desire to seek new markets.

Brainard (1997) found that FDI wasmore evident in cases where there were high transport costs and trade barriersalong with the ability to gain large economies of scale through foreignproduction. In a study carried out by Helpman et al (2003), exploring thedecision factors of US firms seeking to serve markets abroad, it was evidentthat firms would undertake FDI when the relative costs of transporting thegoods outweighed the costs of implementing foreign production facilities. Typically,Swedish firms typically establish foreign affiliates to prevent high transportationcosts and trade barriers (Jordan & Vahlne, 1981).

With wood as a maincomponent, IKEA faces high transportation costs. Through setting up production facilitiesacross Europe, IKEA can produce wooden boards in close proximity to theirfurniture manufacturers. Locating its manufacturing plants near high populationregions such as Ukraine and Western Russia (Ostaszewska, 2016), IKEA has considerably minimised transportationcosts.

Furthermore, FDI can be depictedthrough the level of output the firm intends to serve the market. The largerthe level of output, the more attractive FDI becomes (Porter, 2017). Melitz(2003) further highlighted this by suggesting that the most productive firmsserve the market through FDI and the least productive via export. In 2004,pricing and high duty tax rates posed immense challenges for IKEA whenexporting to China. In 2011, 33 million people visited China’s mainland storesand with a revenue growth of 20%, China is one of IKEA’s fastest-growingmarkets (VanderMey, 2011). With 24current stores and the aim to open three more every year until 2020, movingproduction facilities to China was the most cost-effective strategy for IKEA (IKEA, 2017). Dow (2000) furtherhighlights that low geographical distance will help multinational enterprisesto reduce the cost of operation and therefore price.

Through setting up productionfacilities in China, IKEA has prevented high transportation costs and exporttaxes, enabling a reduction in its prices by more than 60%, with thecorporation seeking to further decline this through mass production and a cutin supply chain costs (Chu, et al., 2013).Incentives for FDI can be extremelycomplex and hard to establish due to the involvement of strategic decisions. IKEA’smotives for setting up foreign affiliations can be assessed through thecost-minimisation theory. With the desire to serve markets on a large scale, inorder for IKEA to minimise costs, such as transportation costs, FDI is deemedmost efficient. However, the interdependence between governments and firmssignals as the most significant factor behind IKEA’s choice to undertake FDI.Through establishing foreign affiliations in countries with low corporate taxrates, using location strategies, has enabled IKEA to disperse their tax burdento countries that offer a more attractive rate. Moreover, throughout theanalysis, it was apparent that both the theory of cost-minimisation and taxationpolicies are not the only factors determining IKEA’s FDI, with basicinfrastructure and the cost and availability of labour having a significantimpact on their decisions.

To further analyse IKEA’s decision to set-up foreignaffiliations, other economic theories should be assessed such as the incentiveto manipulate labour unions, decreasing both host-country and home-countrywages, as well as the impact of government policies such as grants andsubsidies.           References:Chen, C., 2009. China’sIntegration with the Global Economy: WTO Accession, Foreign Direct Investmentand International Trade. 1 ed.

China: Edward Elgar Publishing.Chu, V., Girdhar, A. & Sood, R.,2013.

Business Today. Online Available at: http://www.businesstoday.in/magazine/lbs-case-study/how-ikea-adapted-its-strategies-to-expand-in-china/story/196322.htmlAccessed 2 December 2017.Coase, Ronald H.

, “The Natureof the Firm”.Economica, N.S.

, Vol. 4, London, 1937, pp. 386–405. Repr.In: George J. Stigler and Kenneth E. Boulding (Eds.), Readings in PriceTheory.

Selected by a Committee of the American Economic Association,Homewood, 1953, pp. 331–351.Cushman,D.

O. (1987), “The effects of real wages and labour productivity on FDI”,Southern Economic Journal, Vol. 54, July, pp. 174-85.

De Mooij, R. A. & Ederveen, S.,2003. Taxation and Foreign Direct Investment: A Synthesis of Empirical Research.

International Tax and Public Finance, Volume 10, p. 673–693.Desai, M., Foley, C. and Hines, J., 2004. Foreign directinvestment in a world of multiple taxes. Journal of Public Economics,88(12), pp.

2727-2744.Dow, D., 2000. A Note on Psychological Distance and ExportMarket Selection. Journal of International Marketing, 8(1),pp.51-64.

Dunning, J. H., 2000. The EclecticParadigm As An Envelope For Economic And Business Theories Of MNE Activity. InternationalBusiness Review, 9(2), pp. 163-190.European Commision, 2016.

The AntiTax Avoidance Directive. Online Available at: https://ec.europa.eu/taxation_customs/business/company-tax/anti-tax-avoidance-package/anti-tax-avoidance-directive_enAccessed 2 December 2017.Fortune, 2016. Ikea Has Been Accusedof Avoiding 1 Billion Euros in Taxes.

Online Available at: http://fortune.com/2016/02/12/ikea-tax-avoidance/Accessed3 December 2017.Helpman, E., Yeaple, S. & Melitz,M., 2003.

Export Versus Fdi, Cambridge: National Bureau Of EconomicResearch.Hill, C. & Hult, T., 2017. InternationalBusiness: Competing in the Global Marketplace. Eleventh Edition ed. NewYork: McGraw-Hill Education.

Hymer, Stephen H., TheInternational Operations of National Firms: A Study of Direct ForeignInvestment. M.

I.T. Monographs in Economics, 14, Cambridge, Mass., 1976.IKEA, 2015. Customer Service.

OnlineAvailable at: http://www.ikea.com/ms/en_JP/customer_service/faq/help/about_store/about_stores.html#10Accessed 1 December 2017.IKEA, 2017. IKEA 2017 by numbers. OnlineAvailable at: http://www.ikea.

com/gb/en/this-is-ikea/ikea-highlights/ikea-2017-by-numbers/Accessed 2 December 2017.Jordan,J.L and I.E. Vahlne.

“Domestic Employment Effects of Direct InvestmentAbroad by Two Swedish Multinationals.” Working Paper No, 13, MultinationalEnterprises Programme, Geneva; International Labour Office, 1981. Lingxiu, J.

, 2017. IKEA marketingentry strategy in China. Master thesis in Business Administration, Volume1, pp.

2-51.Loeb, W., 2012.

Forbes. OnlineAvailable at: https://www.forbes.com/sites/walterloeb/2012/12/05/ikea-is-a-world-wide-wonder/#34cacbdf27b9Accessed 2 December 2017.Melitz, M., 2003. The Impact of Trade on Intra-IndustryReallocations and Aggregate Industry Productivity.

 Econometrica,71(6), pp.1695-1725.Mohdin, A., 2017. The five most important charts from the Panama Papers leaks.

Online Quartz.Available from:https://qz.com/654027/the-five-most-important-graphs-from-these-panama-papers-leaks/Accessed 3 Dec. 2017.Oman, C., 2000. Policy Competition for Foreign DirectInvestment: A Study of Competition among Governments to Attract FDI. Paris:OECD Development Publishing Centre.

Ostaszewska, E., 2016. IKEA’s FDI in a Manufacturing Plant in Poland. Berlin Institute for International Business Studies, Volume 2, pp.

3-18. Pfeffermann, G. and Madarassy, A., 1993. Trends in private investment in developing countries 1993. Washington, D.C.

: World Bank. Porter, L., 2017.

Lecture notes title ‘Economics of Strategy 2: Multinationalism & Strategic FDI’. Porter, L., 2017. Lecture notes title ‘Economics of Strategy 2: Public Policy & FDI’. Ralph, P., 2012. Political Science.

1st ed. Melbourne: World Scientific. Rugman, A., 1980. Internalization as a general theory of FDI: A re-appraisal of the literature.

Review of World Economics, 116(2), pp.365–379. Teeffelen, J. v., 2017. Tax Games: the Race to the Bottom, Amsterdam: Eurodad. The Guardian, 2016. Ikea’s taxes scrutinised after €1bn underpayment claim.

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