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Theoretical Basis of Microcosmic GPN Studies
Chapter 2
Theoretical Basis of Microcosmic GPN Studies Chapter Outline 2.1 Multinational Corporations Theory 28 2.1.1 Traditional Theories of Multinational Corporations 28 2.1.2 Strategic Management Theory 28 2.1.3 Network of Multinational Corporations 28 2.2 New Classical Trade Theory 29 2.2.1 New Classical Economics 29 2.2.2 New Classical Trade Theory’s Interpretation of Global Production Network 31
2.3 “New” New Trade Theory 2.3.1 Trade Models with Heterogeneous Firms 2.3.2 Endogenous Boundary Model of the Firm 2.3.3 Interpretation of Global Production Networks in “New” New Trade Theory 2.4 Summary
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As it is noted in Chapter 1, Overview of the Research Into GPNs, there are many shortcomings in the current global production network (GPN) studies in terms of theoretical framework, research subject, dynamic analysis, etc. In particular, the research into international trade has been conducted on corporate level while there are very few GPN studies on the microlevel and a more comprehensive approach is yet to be adopted. This chapter and Chapters 3, Analytical Framework of Microcosmic GPN Studies, explore the theoretical basis and analytical framework of GPN studies on the microlevel, building on the GPN framework proposed by Henderson et al. The basic theories concerning GPNs introduced in Chapter 1, Overview of the Research Into GPNs, including traditional division of labor and international division of labor theories, value chain, value-added chain, global commodity chain (GCC), global value chain (GVC), networks and embeddedness, and actornetwork theory, provide the theoretical basis for microcosmic GPN studies. This chapter focuses on three important theories in this regard, that is, multinational corporations (MNCs) theory, new classical trade theory, and “new” new trade theory, as well as their interpretations of GPNs. Global Value Chains and Production Networks. DOI: https://doi.org/10.1016/B978-0-12-814847-1.00002-6 © 2019 Elsevier Inc. All rights reserved.
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2.1 MULTINATIONAL CORPORATIONS THEORY 2.1.1 Traditional Theories of Multinational Corporations Early theories of MNCs are mainly built on the transaction cost theory and address three core issues, that is, why is it necessary to make foreign direct investment (FDI), what makes successful FDI possible, and where should FDI be located. Typical examples in this regard include monopolistic advantage theory (Hymer, 1960; Kindleberger, 1969), product life cycle theory (Vernon, 1966), internalization theory (Buckley and Casson, 1976), eclectic paradigm (Dunning, 1977, 1979, 1998), etc. These are FDI-related theories developed in the early stage of MNCs and mainly targeted at MNCs in developed countries so they can be considered traditional theories of MNCs. These theories can explain the internal mechanism and conditions of MNCs’ integrated expansion in GPNs, the formation and change of production locations in GPNs, integrated production and hierarchy within MNCs, etc.
2.1.2 Strategic Management Theory The word strategy derives from military activities and it evolved into an approach to business management after World War II, especially in the United States. Igor Ansoff’s Corporate Strategy, the world’s first book about strategy, was published in 1965, marking the beginning of corporate strategy research in modern history. Economic globalization has been an overwhelming trend since the 1980s. MNCs have been looking at the global market and drastic changes have occurred in the competition landscape, driving people to study strategic management in depth. Businesses’ competitive strategies were at the forefront of economic and management studies so competitive strategy theories were further developed and three major models emerged, including industry structure, core competencies, and strategic resources. Michael Porter introduced the theory of industry structure and also proposed the value chain framework, based on which the concepts of value-added chain, GCC, and GVC, direct precursors of the GPN framework, were developed. The theory of core competencies was introduced by C.K. Prahalad and Gary Hamel (1990) and can be used to explain the scale and form of GPNs and the boundary of the firm. The theory of strategic resources proposed by David J. Collins and Cynthia A. Montgomery (Collins and Montgomery, 1995, 2005) can be used to explain the dynamic governance of GPNs.
2.1.3 Network of Multinational Corporations Since the 1990s, economic globalization has been gathering momentum, and GPNs have emerged and been expanding, effecting dramatic changes to the competition and cooperation among MNCs. The competition between individual firms has been gradually replaced by that between consortia of firms.
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As GPNs undergo further changes, modular value chains, relational value chains, captive relationships, and other new types of governance grow in popularity and MNCs no longer make FDI through internalization but form production networks through contract manufacturing, alliances, and other nonequity-based means. Traditional theories of MNCs focus on developed countries, parent firms, hierarchy, and economy but pay little attention to developing countries, subsidiaries, networks, and lack of economy. The strategic management theory addresses competition and competitive advantages much more than the alliances of firms in various forms. Therefore, both face serious challenges in explaining the formation and development of GPNs. Against such a backdrop, the theory about the network of MNCs has drawn increasing attention and includes such concepts as internal network, external network, strategic linkage, and local embeddedness, as summarized by Ye (2008). This theory responds to the changes in organizations and can explain the various factors that cause the formation and evolution of GPNs. It also examines the various network relationships that can be induced or exist inside or outside firms and their structures. The theory offers good explanations about why GPNs exist, network participants and their relations, what network resources firms have access to, what competitive advantages they have, the spatial characteristics of networks, and their relations with regional economy. Its all-round and in-depth examination of how GPNs operate helps us understand the significance of GPNs to the organizational form and performance of MNCs and to local industries and economic development. Therefore, the theory about the network of MNCs is an important theoretical foundation of GPN research.
2.2 NEW CLASSICAL TRADE THEORY 2.2.1 New Classical Economics The division of labor and the economies of scale have been hot topics to economists. The division of labor is the soul of classical economics. It is considered the source of efficiency and productivity, and used by some economists as the logical starting point. Advocated by Dixit, Stiglitz, and Krugman, the economies of scale became a mainstream concept in the field of international economics after the 1970s. However, the theory based on this concept faces some dilemmas: first, the prediction that economic growth and other phenomena will occur if and only if the average size of firms increases is a departure from reality; second, the model adopts a black box approach to firms and fails to address why firms exit and the economic implications of the enterprise system itself so it has difficulty in explaining many modern economic issues; and third, transaction costs do not have substantive meanings in this model since no transaction costs are involved in the increase of firm size and other phenomena.
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After the 1980s, economists represented by Rosen, Becker, Yang, Borland, and Ng used inframarginal analysis to turn brilliant ideas about division of labor and specialization in classical economics into decisionmaking and equilibrium models for explaining all economic activities. This broke down the barriers between traditional macroeconomic and microeconomic models, and started the trend of using modern analytical tools to revive classical economics. They used the endogenous decision-making model for personal choice of specialization level developed based on inframarginal analysis to examine how the market and pricing determine the level of division of labor across all sectors. They interpreted Adam Smith’s division of labor theory and views on the causes of international trade based on the personal decision-making for specialization level and changes in the equilibrium level of division of labor. This new school of thought, known as “new classical economics,” is advocated by economists like Yang Xiaokai. Studies in this regard, proceeding from the evolution of the division of labor, are intended to find the micromechanism of economic growth and establish the microeconomic model of macroeconomic growth. By formalizing the thoughts on division of labor and specialization in classical economics, they change the subject matter of economic research from the optimal allocation of resources under a given structure of economic organizations to the interactions between technology and economic organizations and how such interactions evolve. New classical economics has the following characteristics: First, every decision-maker is both a consumer and a producer and there is no absolute separation between pure consumers and firms. The separation between the two means that the theoretical basis of domestic trade differs from that of international trade. In the case of domestic trade, pure consumers would starve without trading because they do not produce things; in the case of international trade, however, every country is both a consumer and a producer so there are comparative advantages, economies of scale, and preference differences. The assumption that every decision-maker is both a consumer and a producer, according to new classical economics, is closer to the reality and means that the optimal decision representing selfinterested behavior is always the corner solution. Within the framework of consumer producer unity, the model of new classical economics introduces endogenous division of labor, specialization level, and market integration. It is believed that the emergence of firms is endogenous rather than exogenously given and can explain why domestic trade is expanded to international trade. This is a model of endogenous trade. Second, every person favors diversity as a consumer and achieves the economies of specialization as a producer. The economies of specialization have something to do with the scope of a person’s production activities; they are not the economic effect of an increase in firm size. All people’s economies of specialization combined are the economies of division of labor,
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which is the effect of social networks. New classical economics replaces the economies of scale with the economies of specialization and introduces the concept of transaction costs, thus resulting in the dilemma between the economies of specialization and transaction costs. To be specific, on the one hand, specialization enhances productivity and gives decision-makers greater production capacity; on the other hand, due to the diversity in consumer preferences, specialization also means that every decision-maker needs to buy more goods from other specialized decision-makers, which incurs higher transaction costs. Specialization and trade are the basic components of the economy and a main thread that runs through the course of economic development is the dilemma and trade-off between specialization and transaction costs. Third, the analysis of supply and demand is based on corner solution while the marginal analysis based on corner solution is not used. New classical economists still adopt a mathematical method to describe their theory so that the abovementioned views are more scientific. The method they use is inframarginal analysis, that is, to make a marginal analysis of every corner and a cost benefit analysis between corners to find an optimal approach to decision-making. The marginal analysis of every corner is to address the issue of resource allocation with a given division of labor structure and it determines the structure of relative demand for and supply of different products when the total demand is given. The cost benefit analysis between corners determines the specialization level and model (structure of economic organizations) and all people’s decision-making in this regard determines the level of division of labor that determines market capacity and total demand.
2.2.2 New Classical Trade Theory’s Interpretation of Global Production Network New classical economics offers a brand new analytical framework, and reorganizes modern economic theories. It excludes the assumption that producers and consumers are absolutely separated, replaces the concept of economies of scale with that of economies of specialization, and considers the significance of various transaction costs in general equilibrium. A shared framework is established and the new ideas that challenge classical new economics, such as transaction cost economics, property rights economics, new trade theory, endogenous growth theory, evolutionary economics, information economics, and game theory, can be integrated into a new mainstream school of thought. In new classical economics, there is no longer a distinction between microeconomics and macroeconomics or independent development economics, economics of international trade, growth theory, and macroeconomics. There is no absolute separation between pure consumers and producers; the principles of international trade are the same as
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those of domestic trade. New classical economics unifies the isolated branches of economics with an internally consistent core theory, increasing the explanatory power of economics considerably. A new classical trade theory is created using its analytical framework, theoretical paradigm, and analytical approaches. According to the model of new classical trade theory, the level of division of labor and market capacity are both determined by transaction efficiency and rise at the same time as transaction efficiency is enhanced. It means that market capacity and the level of division of labor are the two sides of the same coin (Yang and Zhang, 2003). The basic proposition is that the division of labor will evolve as transaction efficiency is enhanced and economic development, trade, and market structure changes are the different facets of this evolution process. As the division of labor evolves, every person’s specialization level will rise along with productivity, dependence on foreign trade, level of commercialization, endogenous comparative advantage, production concentration, degree of market integration, diversity in economic structure, variety of tradable goods, and the number of related markets while self-sufficiency rate goes down. If transaction efficiency is extremely high, the whole world will be an integrated market due to the full division of labor (Yang and Zhang, 2003). New classical economics applies the analytical approach to the division of labor and trade among individuals to the international division of labor and international trade, reexamines the international trade theory using the individual specialization decision-making model in the context of the dilemma and trade-off between the economies of division of labor and transaction costs, and offers new explanations about the basic issues of trade theory with a model of division of labor evolution. The new classical trade theory with division of labor and specialization at the core can analyze the economic reality that GPNs as a new way of organizing production is growing in popularity from a more rigorous and standard perspective of economics. It explores technology transfer and spillover, trade in intermediate goods and inputs, trade and economic growth, industrial upgrading, increase in employment, MNCs’ industrial organization, and gains from trade on the microlevel. This will lead to different explanations about key issues such as the causes, models, and outcomes of trade from those offered by traditional international trade theory, and it can be used to analyze corresponding economic policies. The new classical trade theory is intended to find out the micromechanism of economic growth using a scientific approach and build a micromodel of macroeconomic growth so it is a basic theory of crucial importance to microcosmic GPN studies. According to new classical economics, the creation of GPNs as a new type of international production organization is caused by the endogenous evolution of division of labor. GPNs in which MNCs are the main players are in essence a new model of international division of labor and the direct
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outcome of individual specialization decision-making and division of labor across sectors. The cause is the endogenous advantage brought and reinforced by division of labor and specialization. GPNs make it possible to put different stages of the production process in different countries so that the benefits of specialization can be fully exploited, that is, helping to promote knowledge building and learning outcomes among all parties involved in the division of labor, improve productivity, achieve increasing returns to scale, and eventually reduce production costs, build the competitiveness of specialized firms, and bring about an increase in economic growth and social welfare. The advancement of trade and investment liberalization worldwide provides the institutional support for the formation of GPNs while technological advances play an important role in driving the development of GPNs. These technical and institutional factors have reduced barriers to the division of labor worldwide significantly, and improved transaction efficiency. Therefore, MNCs are active in creating and expanding GPNs. Moreover, the development of GPNs and increase in the number of stages in the crossborder division of labor will result in a rise in transaction costs. To benefit as much as possible from the division of labor, the government has to keep improving the economic system to lower various transaction costs, and works to increase specialization and improve the scale of every stage in the division of labor, which in turn leads to a further decrease in transaction costs. The benign interactions between the two brings about dynamic effects of learning and sustained growth. According to new classical economics, both domestic trade and international trade are the results of a trade-off between the economies of specialization and the need to reduce transaction costs; international trade is the outcome of domestic trade development. This can also explain the evolution of MNCs’ efforts to create GPNs. When transaction efficiency is low enough, self-sufficiency rate is in general equilibrium and firms tend to be internally integrated. As transaction efficiency increases, domestic division of labor advances and some lead firms begin to create national production networks and introduce cooperation with other firms at home. When transaction efficiency continues to rise, the division of labor goes deeper and beyond the domestic market, international division of labor and trade emerges, and lead firms begin to create GPNs and engage in cross-border cooperation. The consumer producer assumption applies perfectly to a country so individual decision-making process has explanatory power in the analysis of countries’ economic behavior. As long as the benefits brought by division of labor among countries exceed the transaction costs incurred by international trade, countries will choose specialization and trade with other countries, resulting in the formation and expansion of GPNs. Besides, a bigger market provides more space for the trade-off between the benefits brought by division of labor and transaction costs. GPNs emerge after
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national production networks because international trade incurs additional transaction costs compared with domestic trade. According to new classical economics, the degree of a country’s involvement in GPNs can also be explained by the level of division of labor and transaction efficiency. Developed countries have higher transaction efficiency and equilibrium level of division of labor than developing countries so they need international trade to benefit fully from the high level of division of labor. This is also why developed countries tend to adopt unilateral free trade and actively expand GPNs. In contrast, developing countries have lower transaction efficiency and equilibrium level of division of labor and benefit little from international trade so they tend to change the relative prices of tradable goods through tariffs and other means so as to make more gains from trade. Therefore, the key to developing a country’s economy leveraging GPNs is to improve transaction efficiency and create endogenous comparative advantages through the division of labor rather than simply rely on exogenous comparative advantages. Transaction cost or transaction efficiency is a core concept in the theoretical framework of new classical economics. It is a key factor that determines the division of labor and specialization in economies as well as the types of economic organization. The scale, scope, and depth of the division of labor within GPNs are determined by the comparison between the marginal benefit and marginal transaction cost of the division of labor. If the former is greater than the latter, intranetwork division of labor will go deeper and GPNs will continue to develop; if the former is lesser than the latter, intranetwork division of labor and GPNs will tend to shrink. New classical economics draws distinctions between different types of transaction cost from the perspective of division of labor. It distinguishes between endogenous and exogenous transaction costs and endogenous transaction costs are divided into transaction costs in narrow and broad senses. A new classical property rights theory is also developed based on this. New classical economics focuses the research into transaction costs. The significance of the research is that making the degree of monopoly and externality endogenous according to the dilemma helps to study moral hazard and transaction costs incurred by information asymmetry and the game theory can be used to examine interactions between strategic moves. According to new classical economics, the government should be committed to lowering transaction costs through means in two aspects so that more firms are involved in GPNs and sustained economic growth can be achieved. On the front of exogenous transaction costs, the government should encourage technological advances and bring down hard or tangible costs such as transportation and communication costs. On the front of endogenous transaction costs, the government should keep working on institutional innovation within important frameworks such as WTO rules and achieve multilateral free trade through negotiations, reduce tariff and nontariff barriers, improve the legal framework, relax administrative
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regulation, enhance management efficiency, and lower soft or intangible costs to drive the division of labor to go wider and deeper and bring greater productivity gains. The latter is particularly important to developing countries including China.1,2
2.3 “NEW” NEW TRADE THEORY Since the beginning of the 21st century, a new international trade system with firms at the core has emerged as the international division of labor and globalization of business activities goes further. The effects of firms’ different characteristics on international trade in different fields have become a hot research topic of international economics. “New” new trade theory3 represented by trade models with heterogeneous firms and endogenous boundary model of the firm has emerged as the latest theory of international trade. “New” new trade theory breaks with the firm homogeneity assumption in traditional trade theory and new trade theory and includes heterogeneity in the analytical framework for firms so that the variables of analysis are changed from countries and industries on the macrolevel to firms on the microlevel (Fan, 2007). The analysis of firms’ trade and investment for internationalization and outsourcing and integration for global organization of production marks a new area of international trade research. The concept of “new” new trade theory was first proposed by Baldwin and Nicoud (2004) but the earliest studies were conducted by Melitz (2003), Antras (2003), and Bernard et al. (2003). The theory has two branches. One of them concerns the choice of internationalization, based on the study by Melitz (2003), is also known as trade models with heterogeneous firms, and it explains why in reality only some firms choose export and FDI. The other concerns the choice of global organization of production, based on the study by Antras (2003), and is also known as endogenous boundary model of the firm. It integrates the concepts of industry organization and contract into the trade model, well explains intrafirm trade, and introduces a theoretical innovation in the research into firms’ global production.4
1. The concept of “local embeddedness” was proposed very early but Yang and Xia (2005) were the first to suggest replacing the traditional concept of “location advantage” with “local embeddedness.” 2. Based on related studies, including Yang (1997 and 1998), Yang and Huang (1999, 2003), and Yang and Zhang (2003). 3. In some literature, the endogenous boundary model of the firm is considered the extension of trade models with heterogeneous firms. In this book, the concept of “new” new trade theory is adopted to stress their difference in the area of research. 4. Based on related studies, including Melitz (2003), Helpman et al. (2004), Helpman (2006) and Li (2010).
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2.3.1 Trade Models with Heterogeneous Firms In the early 1980s, new trade theory included heterogeneity in the trade model to explain the phenomenon of interindustry trade but the heterogeneity was mainly reflected in product differences and monopolistic competition and no attention was paid to the differences between firms in productivity. Therefore, it is assumed that firms in the same industry are symmetrical and at the same technological level, all firms have the same productivity level, and all other firms will also export if one firm exports. However, more and more empirical studies have proved that the symmetry assumption of new trade theory has major limitations. In the 1990s, a large number of empirical studies on firms showed that only some firms export products to other countries and exporting firms are better than nonexporting firms in terms of size and productivity. Melitz (2003) combines the monopolistic competition model of new trade theory with the firm heterogeneity assumption and constructs a model of intraindustry dynamics with heterogeneous firms. The model builds the general-equilibrium monopolistic competition model with industry dynamics of Hopenhayn (1992), expands the trade model of Krugman (1980), and introduces firms’ differences in productivity. Melitz examines the relationship between international trade and intraindustry resource allocation and proves that firms with higher productivity take the initiative to enter the export market while firms with lower productivity are forced to exit from the market so that the productivity level of the entire industry is raised and that trade brings development opportunities for some firms and great challenges to others. The predictions made based on this model basically go with those of empirical studies so it is widely acknowledged that the research into firm heterogeneity and the basic framework of international trade and investment has great significance of theoretical foundation.5,6 Many theoretical models introduced after Melitz (2003) can well explain the relationship between heterogeneous firms and their internationalization moves. Building on the Melitz model, Helpman et al. (2004) include heterogeneous firms, export and FDI in the same analytical framework, construct a multicountry, multisector, general-equilibrium model to examine firms’ export and FDI activities, and prove that firms’ productivity difference is an important factor affecting their export and FDI. Yeaple (2005) attempts to explain the systematic differences between exporting and nonexporting firms
5. For individual firms, A can be considered an exogenous variable since the market size can be deemed infinitely great. E stands for total expenditure and J for the variety of differentiated goods. 6. According to the market clearing condition, it can be concluded that the output of the firm is “A(a/α)A/α ε,” total income “A(a/α)A/α1 ε,” and variable costs “αA(a/α)A/α1 ε.”
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and effectively explains why skill premium has been growing by connecting trade costs with firms’ decision-making in four aspects, that is, entry, technology, export, and worker type. Melitz and Ottaviano (2008) construct a variable markup model in analyzing the relations among market size, productivity, and trade, and prove that market size and trade will affect the intensity of competition and heterogeneous firms’ production decision. Bernard et al. (2007) successfully explain the causes of intraindustry trade and find factors that influence firms’ entry into the export market by introducing firm heterogeneity in a standard trade model. Helpman et al. (2007) create a theoretical model for analyzing MNCs’ choice of integration strategy by combining firm heterogeneity with two types of FDI (vertical FDI and horizontal FDI). Manova (2008) integrates credit constraint in the model of Melitz (2003) and finds that firms with higher productivity enjoy advantages in winning export credit support and firms in financially developed countries have easier access to the export market and export more products, particularly in sectors that rely on external financing.
2.3.2 Endogenous Boundary Model of the Firm There are two basic models of firm boundary. One is to apply the transaction cost theory of Coase and Williamson to the study of business internationalization; the other is to adopt the property right analysis method of Grossman et al. (2003) combines the Grossman Hart Moore firm theory with the Helpman Krugman new trade theory in the same analytical framework and proposes a model of incomplete contract and property right model concerning firm boundary to analyze MNCs’ positioning and control decision, which marks the starting point of the endogenous boundary model of the firm. The model defines MNCs’ boundary and the international position of production and can be used to predict the type of intrafirm trade. Inspection by variables show that the qualitative and quantitative characteristics of the model and data are consistent. Antras and Helpman (2004) combine the trade models with heterogeneous firms proposed by Melitz (2003) and the endogenous boundary model of the firm proposed by Antras (2003) to create a new theoretical model that analyzes firms’ behavior in international business from their differences in organizational structure and concludes that the decisions on outsourcing or integration, operating at home or abroad, etc. are all firms’ endogenous organizational choices. Antras (2005) creates a dynamic generalequilibrium model of North South trade to explain the appearance of product life cycle caused by the incompleteness of international contracts. Antras and Helpman (2006) generalize the international production organization model with heterogeneous firms proposed by Antras and Helpman (2004), introduce contractual frictions in the model, and allows for their varying degrees according to inputs and country. This model suggests that firms’
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productivity level would influence their strategic choice of organizational form.7,8 In general, the endogenous boundary model of the firm proceeds from the organizational choice of individual firms and combines international trade theory with firm theory in the same framework. It marks a further development in the trade theory with heterogeneous firms and offers a brand new perspective for the research into firms’ globalization and industrial organization. The endogenous boundary model of the firm is typically started by the studies of Antras (2003) and Antras and Helpman (2004), examines firm heterogeneity’s influence on the strategic choice of outsourcing and insourcing, and explores how firms’ organizational form affects trade model.
2.3.3 Interpretation of Global Production Networks in “New” New Trade Theory The “new” new trade theory is highly consistent with microcosmic GPN studies. The inclusion of the theory in the GPN framework provides a new microbasis and new perspectives for the research into GPNs. The theory can explain the heterogeneity and power asymmetry of firms in GPNs, including the behavioral pattern and inner traits of firms and productivity, technology, and workers with heterogeneous skills as the sources of heterogeneity. In conjunction with the fixed costs of trade, the theory can explain firms’ productivity differences, and be used to analyze the influence of firms’ organizational form on international trade and GPNs and in particular, the features and causes of international trade within MNCs, thus enriching the research into GPNs. The “new” new trade theory mainly explains the following issues about GPNs: what kind of firms would create GPNs to serve international markets; what organizational forms would they choose (export or FDI, horizontal or vertical FDI, creation of new business or cross-border M&A, and outsourcing or integration); how do they choose locations (domestic or international and South or North); can GPNs improve firms’ performance and competitiveness. Therefore, the “new” new trade theory offers significant support to microcosmic GPN studies. The “new” new trade theory proceeds from firm heterogeneity in explaining the benefits of GPNs. Countries and regions that lag behind should be actively involved in the international division of labor and raise the level of openness to the outside world, which will help enhance industry productivity and promote local economic development. The theory finds a new way of improving productivity. Under the condition that the productivity of 7. This does not include the export of foreign-funded enterprises since only the behavior of domestic enterprises is the subject of study here. 8. According to the market clearing condition, it can be concluded that the output of the firm is “A(a/α)A/α ε,” total income “A(a/α)A/α1 ε,” and variable costs “αA(a/α)A/α1 ε.”
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individual firms stays unchanged, a country can still raise the level of productivity in an industry and even across all sectors through trade and opening up. It also suggests that GPNs may have negative impacts on less developed regions. Opening the market may plunge industries with lower efficiency in less developed regions into recession and industries entering less developed regions may be industries with low productivity and high environmental costs. Business relocation may lead to a reversion in small countries’ productivity gains while helping increase big countries’ productivity gains. GPNs lead to the reallocation of resources and the shift of profit and market share to firms with high productivity, which may cause excessive resource monopoly and thus loss of efficiency in the entire market.
2.4 SUMMARY This chapter focuses on three basic theories important to microcosmic GPN studies, including MNCs theory, new classical trade theory, and “new” new trade theory, as well as their interpretation of GPNs. The MNCs theory can explain such issues as the formation and evolution of GPNs; network participants and their relationships; internal mechanism and conditions of MNCs’ integrated expansion; operation mechanism and dynamic governance of networks; spatial characteristics of networks and their relations with regional economy, scale, and form of GPNs; and boundary of the firm. The new classical trade theory with the division of labor and specialization at the core can analyze the economic reality that GPNs as a new way of organizing production is growing in popularity from a more rigorous and standard perspective of economics. It explores technology transfer and spillover, trade in intermediate goods and inputs, trade and economic growth, industrial upgrading, increase in employment, MNCs’ industrial organization and gains from trade on the microlevel. This will lead to different explanations about key issues such as the causes, models, and outcomes of trade from those offered by traditional international trade theory. The “new” new trade theory is highly consistent with microcosmic GPN studies, and can explain the heterogeneity and power asymmetry of firms in GPNs, and firms’ productivity differences. It can be used to analyze the influence of firms’ organizational form on international trade and GPNs and in particular, the features and causes of international trade within MNCs, thus enriching the research into GPNs. In short, these basic theories are of crucial importance to microcosmic GPN studies.
Theoretical Basis of Microcosmic GPN Studies Chapter Outline 2.1 Multinational Corporations Theory 28 2.1.1 Traditional Theories of Multinational Corporations 28 2.1.2 Strategic Management Theory 28 2.1.3 Network of Multinational Corporations 28 2.2 New Classical Trade Theory 29 2.2.1 New Classical Economics 29 2.2.2 New Classical Trade Theory’s Interpretation of Global Production Network 31
2.3 “New” New Trade Theory 2.3.1 Trade Models with Heterogeneous Firms 2.3.2 Endogenous Boundary Model of the Firm 2.3.3 Interpretation of Global Production Networks in “New” New Trade Theory 2.4 Summary
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As it is noted in Chapter 1, Overview of the Research Into GPNs, there are many shortcomings in the current global production network (GPN) studies in terms of theoretical framework, research subject, dynamic analysis, etc. In particular, the research into international trade has been conducted on corporate level while there are very few GPN studies on the microlevel and a more comprehensive approach is yet to be adopted. This chapter and Chapters 3, Analytical Framework of Microcosmic GPN Studies, explore the theoretical basis and analytical framework of GPN studies on the microlevel, building on the GPN framework proposed by Henderson et al. The basic theories concerning GPNs introduced in Chapter 1, Overview of the Research Into GPNs, including traditional division of labor and international division of labor theories, value chain, value-added chain, global commodity chain (GCC), global value chain (GVC), networks and embeddedness, and actornetwork theory, provide the theoretical basis for microcosmic GPN studies. This chapter focuses on three important theories in this regard, that is, multinational corporations (MNCs) theory, new classical trade theory, and “new” new trade theory, as well as their interpretations of GPNs. Global Value Chains and Production Networks. DOI: https://doi.org/10.1016/B978-0-12-814847-1.00002-6 © 2019 Elsevier Inc. All rights reserved.
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2.1 MULTINATIONAL CORPORATIONS THEORY 2.1.1 Traditional Theories of Multinational Corporations Early theories of MNCs are mainly built on the transaction cost theory and address three core issues, that is, why is it necessary to make foreign direct investment (FDI), what makes successful FDI possible, and where should FDI be located. Typical examples in this regard include monopolistic advantage theory (Hymer, 1960; Kindleberger, 1969), product life cycle theory (Vernon, 1966), internalization theory (Buckley and Casson, 1976), eclectic paradigm (Dunning, 1977, 1979, 1998), etc. These are FDI-related theories developed in the early stage of MNCs and mainly targeted at MNCs in developed countries so they can be considered traditional theories of MNCs. These theories can explain the internal mechanism and conditions of MNCs’ integrated expansion in GPNs, the formation and change of production locations in GPNs, integrated production and hierarchy within MNCs, etc.
2.1.2 Strategic Management Theory The word strategy derives from military activities and it evolved into an approach to business management after World War II, especially in the United States. Igor Ansoff’s Corporate Strategy, the world’s first book about strategy, was published in 1965, marking the beginning of corporate strategy research in modern history. Economic globalization has been an overwhelming trend since the 1980s. MNCs have been looking at the global market and drastic changes have occurred in the competition landscape, driving people to study strategic management in depth. Businesses’ competitive strategies were at the forefront of economic and management studies so competitive strategy theories were further developed and three major models emerged, including industry structure, core competencies, and strategic resources. Michael Porter introduced the theory of industry structure and also proposed the value chain framework, based on which the concepts of value-added chain, GCC, and GVC, direct precursors of the GPN framework, were developed. The theory of core competencies was introduced by C.K. Prahalad and Gary Hamel (1990) and can be used to explain the scale and form of GPNs and the boundary of the firm. The theory of strategic resources proposed by David J. Collins and Cynthia A. Montgomery (Collins and Montgomery, 1995, 2005) can be used to explain the dynamic governance of GPNs.
2.1.3 Network of Multinational Corporations Since the 1990s, economic globalization has been gathering momentum, and GPNs have emerged and been expanding, effecting dramatic changes to the competition and cooperation among MNCs. The competition between individual firms has been gradually replaced by that between consortia of firms.
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As GPNs undergo further changes, modular value chains, relational value chains, captive relationships, and other new types of governance grow in popularity and MNCs no longer make FDI through internalization but form production networks through contract manufacturing, alliances, and other nonequity-based means. Traditional theories of MNCs focus on developed countries, parent firms, hierarchy, and economy but pay little attention to developing countries, subsidiaries, networks, and lack of economy. The strategic management theory addresses competition and competitive advantages much more than the alliances of firms in various forms. Therefore, both face serious challenges in explaining the formation and development of GPNs. Against such a backdrop, the theory about the network of MNCs has drawn increasing attention and includes such concepts as internal network, external network, strategic linkage, and local embeddedness, as summarized by Ye (2008). This theory responds to the changes in organizations and can explain the various factors that cause the formation and evolution of GPNs. It also examines the various network relationships that can be induced or exist inside or outside firms and their structures. The theory offers good explanations about why GPNs exist, network participants and their relations, what network resources firms have access to, what competitive advantages they have, the spatial characteristics of networks, and their relations with regional economy. Its all-round and in-depth examination of how GPNs operate helps us understand the significance of GPNs to the organizational form and performance of MNCs and to local industries and economic development. Therefore, the theory about the network of MNCs is an important theoretical foundation of GPN research.
2.2 NEW CLASSICAL TRADE THEORY 2.2.1 New Classical Economics The division of labor and the economies of scale have been hot topics to economists. The division of labor is the soul of classical economics. It is considered the source of efficiency and productivity, and used by some economists as the logical starting point. Advocated by Dixit, Stiglitz, and Krugman, the economies of scale became a mainstream concept in the field of international economics after the 1970s. However, the theory based on this concept faces some dilemmas: first, the prediction that economic growth and other phenomena will occur if and only if the average size of firms increases is a departure from reality; second, the model adopts a black box approach to firms and fails to address why firms exit and the economic implications of the enterprise system itself so it has difficulty in explaining many modern economic issues; and third, transaction costs do not have substantive meanings in this model since no transaction costs are involved in the increase of firm size and other phenomena.
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After the 1980s, economists represented by Rosen, Becker, Yang, Borland, and Ng used inframarginal analysis to turn brilliant ideas about division of labor and specialization in classical economics into decisionmaking and equilibrium models for explaining all economic activities. This broke down the barriers between traditional macroeconomic and microeconomic models, and started the trend of using modern analytical tools to revive classical economics. They used the endogenous decision-making model for personal choice of specialization level developed based on inframarginal analysis to examine how the market and pricing determine the level of division of labor across all sectors. They interpreted Adam Smith’s division of labor theory and views on the causes of international trade based on the personal decision-making for specialization level and changes in the equilibrium level of division of labor. This new school of thought, known as “new classical economics,” is advocated by economists like Yang Xiaokai. Studies in this regard, proceeding from the evolution of the division of labor, are intended to find the micromechanism of economic growth and establish the microeconomic model of macroeconomic growth. By formalizing the thoughts on division of labor and specialization in classical economics, they change the subject matter of economic research from the optimal allocation of resources under a given structure of economic organizations to the interactions between technology and economic organizations and how such interactions evolve. New classical economics has the following characteristics: First, every decision-maker is both a consumer and a producer and there is no absolute separation between pure consumers and firms. The separation between the two means that the theoretical basis of domestic trade differs from that of international trade. In the case of domestic trade, pure consumers would starve without trading because they do not produce things; in the case of international trade, however, every country is both a consumer and a producer so there are comparative advantages, economies of scale, and preference differences. The assumption that every decision-maker is both a consumer and a producer, according to new classical economics, is closer to the reality and means that the optimal decision representing selfinterested behavior is always the corner solution. Within the framework of consumer producer unity, the model of new classical economics introduces endogenous division of labor, specialization level, and market integration. It is believed that the emergence of firms is endogenous rather than exogenously given and can explain why domestic trade is expanded to international trade. This is a model of endogenous trade. Second, every person favors diversity as a consumer and achieves the economies of specialization as a producer. The economies of specialization have something to do with the scope of a person’s production activities; they are not the economic effect of an increase in firm size. All people’s economies of specialization combined are the economies of division of labor,
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which is the effect of social networks. New classical economics replaces the economies of scale with the economies of specialization and introduces the concept of transaction costs, thus resulting in the dilemma between the economies of specialization and transaction costs. To be specific, on the one hand, specialization enhances productivity and gives decision-makers greater production capacity; on the other hand, due to the diversity in consumer preferences, specialization also means that every decision-maker needs to buy more goods from other specialized decision-makers, which incurs higher transaction costs. Specialization and trade are the basic components of the economy and a main thread that runs through the course of economic development is the dilemma and trade-off between specialization and transaction costs. Third, the analysis of supply and demand is based on corner solution while the marginal analysis based on corner solution is not used. New classical economists still adopt a mathematical method to describe their theory so that the abovementioned views are more scientific. The method they use is inframarginal analysis, that is, to make a marginal analysis of every corner and a cost benefit analysis between corners to find an optimal approach to decision-making. The marginal analysis of every corner is to address the issue of resource allocation with a given division of labor structure and it determines the structure of relative demand for and supply of different products when the total demand is given. The cost benefit analysis between corners determines the specialization level and model (structure of economic organizations) and all people’s decision-making in this regard determines the level of division of labor that determines market capacity and total demand.
2.2.2 New Classical Trade Theory’s Interpretation of Global Production Network New classical economics offers a brand new analytical framework, and reorganizes modern economic theories. It excludes the assumption that producers and consumers are absolutely separated, replaces the concept of economies of scale with that of economies of specialization, and considers the significance of various transaction costs in general equilibrium. A shared framework is established and the new ideas that challenge classical new economics, such as transaction cost economics, property rights economics, new trade theory, endogenous growth theory, evolutionary economics, information economics, and game theory, can be integrated into a new mainstream school of thought. In new classical economics, there is no longer a distinction between microeconomics and macroeconomics or independent development economics, economics of international trade, growth theory, and macroeconomics. There is no absolute separation between pure consumers and producers; the principles of international trade are the same as
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those of domestic trade. New classical economics unifies the isolated branches of economics with an internally consistent core theory, increasing the explanatory power of economics considerably. A new classical trade theory is created using its analytical framework, theoretical paradigm, and analytical approaches. According to the model of new classical trade theory, the level of division of labor and market capacity are both determined by transaction efficiency and rise at the same time as transaction efficiency is enhanced. It means that market capacity and the level of division of labor are the two sides of the same coin (Yang and Zhang, 2003). The basic proposition is that the division of labor will evolve as transaction efficiency is enhanced and economic development, trade, and market structure changes are the different facets of this evolution process. As the division of labor evolves, every person’s specialization level will rise along with productivity, dependence on foreign trade, level of commercialization, endogenous comparative advantage, production concentration, degree of market integration, diversity in economic structure, variety of tradable goods, and the number of related markets while self-sufficiency rate goes down. If transaction efficiency is extremely high, the whole world will be an integrated market due to the full division of labor (Yang and Zhang, 2003). New classical economics applies the analytical approach to the division of labor and trade among individuals to the international division of labor and international trade, reexamines the international trade theory using the individual specialization decision-making model in the context of the dilemma and trade-off between the economies of division of labor and transaction costs, and offers new explanations about the basic issues of trade theory with a model of division of labor evolution. The new classical trade theory with division of labor and specialization at the core can analyze the economic reality that GPNs as a new way of organizing production is growing in popularity from a more rigorous and standard perspective of economics. It explores technology transfer and spillover, trade in intermediate goods and inputs, trade and economic growth, industrial upgrading, increase in employment, MNCs’ industrial organization, and gains from trade on the microlevel. This will lead to different explanations about key issues such as the causes, models, and outcomes of trade from those offered by traditional international trade theory, and it can be used to analyze corresponding economic policies. The new classical trade theory is intended to find out the micromechanism of economic growth using a scientific approach and build a micromodel of macroeconomic growth so it is a basic theory of crucial importance to microcosmic GPN studies. According to new classical economics, the creation of GPNs as a new type of international production organization is caused by the endogenous evolution of division of labor. GPNs in which MNCs are the main players are in essence a new model of international division of labor and the direct
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outcome of individual specialization decision-making and division of labor across sectors. The cause is the endogenous advantage brought and reinforced by division of labor and specialization. GPNs make it possible to put different stages of the production process in different countries so that the benefits of specialization can be fully exploited, that is, helping to promote knowledge building and learning outcomes among all parties involved in the division of labor, improve productivity, achieve increasing returns to scale, and eventually reduce production costs, build the competitiveness of specialized firms, and bring about an increase in economic growth and social welfare. The advancement of trade and investment liberalization worldwide provides the institutional support for the formation of GPNs while technological advances play an important role in driving the development of GPNs. These technical and institutional factors have reduced barriers to the division of labor worldwide significantly, and improved transaction efficiency. Therefore, MNCs are active in creating and expanding GPNs. Moreover, the development of GPNs and increase in the number of stages in the crossborder division of labor will result in a rise in transaction costs. To benefit as much as possible from the division of labor, the government has to keep improving the economic system to lower various transaction costs, and works to increase specialization and improve the scale of every stage in the division of labor, which in turn leads to a further decrease in transaction costs. The benign interactions between the two brings about dynamic effects of learning and sustained growth. According to new classical economics, both domestic trade and international trade are the results of a trade-off between the economies of specialization and the need to reduce transaction costs; international trade is the outcome of domestic trade development. This can also explain the evolution of MNCs’ efforts to create GPNs. When transaction efficiency is low enough, self-sufficiency rate is in general equilibrium and firms tend to be internally integrated. As transaction efficiency increases, domestic division of labor advances and some lead firms begin to create national production networks and introduce cooperation with other firms at home. When transaction efficiency continues to rise, the division of labor goes deeper and beyond the domestic market, international division of labor and trade emerges, and lead firms begin to create GPNs and engage in cross-border cooperation. The consumer producer assumption applies perfectly to a country so individual decision-making process has explanatory power in the analysis of countries’ economic behavior. As long as the benefits brought by division of labor among countries exceed the transaction costs incurred by international trade, countries will choose specialization and trade with other countries, resulting in the formation and expansion of GPNs. Besides, a bigger market provides more space for the trade-off between the benefits brought by division of labor and transaction costs. GPNs emerge after
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national production networks because international trade incurs additional transaction costs compared with domestic trade. According to new classical economics, the degree of a country’s involvement in GPNs can also be explained by the level of division of labor and transaction efficiency. Developed countries have higher transaction efficiency and equilibrium level of division of labor than developing countries so they need international trade to benefit fully from the high level of division of labor. This is also why developed countries tend to adopt unilateral free trade and actively expand GPNs. In contrast, developing countries have lower transaction efficiency and equilibrium level of division of labor and benefit little from international trade so they tend to change the relative prices of tradable goods through tariffs and other means so as to make more gains from trade. Therefore, the key to developing a country’s economy leveraging GPNs is to improve transaction efficiency and create endogenous comparative advantages through the division of labor rather than simply rely on exogenous comparative advantages. Transaction cost or transaction efficiency is a core concept in the theoretical framework of new classical economics. It is a key factor that determines the division of labor and specialization in economies as well as the types of economic organization. The scale, scope, and depth of the division of labor within GPNs are determined by the comparison between the marginal benefit and marginal transaction cost of the division of labor. If the former is greater than the latter, intranetwork division of labor will go deeper and GPNs will continue to develop; if the former is lesser than the latter, intranetwork division of labor and GPNs will tend to shrink. New classical economics draws distinctions between different types of transaction cost from the perspective of division of labor. It distinguishes between endogenous and exogenous transaction costs and endogenous transaction costs are divided into transaction costs in narrow and broad senses. A new classical property rights theory is also developed based on this. New classical economics focuses the research into transaction costs. The significance of the research is that making the degree of monopoly and externality endogenous according to the dilemma helps to study moral hazard and transaction costs incurred by information asymmetry and the game theory can be used to examine interactions between strategic moves. According to new classical economics, the government should be committed to lowering transaction costs through means in two aspects so that more firms are involved in GPNs and sustained economic growth can be achieved. On the front of exogenous transaction costs, the government should encourage technological advances and bring down hard or tangible costs such as transportation and communication costs. On the front of endogenous transaction costs, the government should keep working on institutional innovation within important frameworks such as WTO rules and achieve multilateral free trade through negotiations, reduce tariff and nontariff barriers, improve the legal framework, relax administrative
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regulation, enhance management efficiency, and lower soft or intangible costs to drive the division of labor to go wider and deeper and bring greater productivity gains. The latter is particularly important to developing countries including China.1,2
2.3 “NEW” NEW TRADE THEORY Since the beginning of the 21st century, a new international trade system with firms at the core has emerged as the international division of labor and globalization of business activities goes further. The effects of firms’ different characteristics on international trade in different fields have become a hot research topic of international economics. “New” new trade theory3 represented by trade models with heterogeneous firms and endogenous boundary model of the firm has emerged as the latest theory of international trade. “New” new trade theory breaks with the firm homogeneity assumption in traditional trade theory and new trade theory and includes heterogeneity in the analytical framework for firms so that the variables of analysis are changed from countries and industries on the macrolevel to firms on the microlevel (Fan, 2007). The analysis of firms’ trade and investment for internationalization and outsourcing and integration for global organization of production marks a new area of international trade research. The concept of “new” new trade theory was first proposed by Baldwin and Nicoud (2004) but the earliest studies were conducted by Melitz (2003), Antras (2003), and Bernard et al. (2003). The theory has two branches. One of them concerns the choice of internationalization, based on the study by Melitz (2003), is also known as trade models with heterogeneous firms, and it explains why in reality only some firms choose export and FDI. The other concerns the choice of global organization of production, based on the study by Antras (2003), and is also known as endogenous boundary model of the firm. It integrates the concepts of industry organization and contract into the trade model, well explains intrafirm trade, and introduces a theoretical innovation in the research into firms’ global production.4
1. The concept of “local embeddedness” was proposed very early but Yang and Xia (2005) were the first to suggest replacing the traditional concept of “location advantage” with “local embeddedness.” 2. Based on related studies, including Yang (1997 and 1998), Yang and Huang (1999, 2003), and Yang and Zhang (2003). 3. In some literature, the endogenous boundary model of the firm is considered the extension of trade models with heterogeneous firms. In this book, the concept of “new” new trade theory is adopted to stress their difference in the area of research. 4. Based on related studies, including Melitz (2003), Helpman et al. (2004), Helpman (2006) and Li (2010).
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2.3.1 Trade Models with Heterogeneous Firms In the early 1980s, new trade theory included heterogeneity in the trade model to explain the phenomenon of interindustry trade but the heterogeneity was mainly reflected in product differences and monopolistic competition and no attention was paid to the differences between firms in productivity. Therefore, it is assumed that firms in the same industry are symmetrical and at the same technological level, all firms have the same productivity level, and all other firms will also export if one firm exports. However, more and more empirical studies have proved that the symmetry assumption of new trade theory has major limitations. In the 1990s, a large number of empirical studies on firms showed that only some firms export products to other countries and exporting firms are better than nonexporting firms in terms of size and productivity. Melitz (2003) combines the monopolistic competition model of new trade theory with the firm heterogeneity assumption and constructs a model of intraindustry dynamics with heterogeneous firms. The model builds the general-equilibrium monopolistic competition model with industry dynamics of Hopenhayn (1992), expands the trade model of Krugman (1980), and introduces firms’ differences in productivity. Melitz examines the relationship between international trade and intraindustry resource allocation and proves that firms with higher productivity take the initiative to enter the export market while firms with lower productivity are forced to exit from the market so that the productivity level of the entire industry is raised and that trade brings development opportunities for some firms and great challenges to others. The predictions made based on this model basically go with those of empirical studies so it is widely acknowledged that the research into firm heterogeneity and the basic framework of international trade and investment has great significance of theoretical foundation.5,6 Many theoretical models introduced after Melitz (2003) can well explain the relationship between heterogeneous firms and their internationalization moves. Building on the Melitz model, Helpman et al. (2004) include heterogeneous firms, export and FDI in the same analytical framework, construct a multicountry, multisector, general-equilibrium model to examine firms’ export and FDI activities, and prove that firms’ productivity difference is an important factor affecting their export and FDI. Yeaple (2005) attempts to explain the systematic differences between exporting and nonexporting firms
5. For individual firms, A can be considered an exogenous variable since the market size can be deemed infinitely great. E stands for total expenditure and J for the variety of differentiated goods. 6. According to the market clearing condition, it can be concluded that the output of the firm is “A(a/α)A/α ε,” total income “A(a/α)A/α1 ε,” and variable costs “αA(a/α)A/α1 ε.”
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and effectively explains why skill premium has been growing by connecting trade costs with firms’ decision-making in four aspects, that is, entry, technology, export, and worker type. Melitz and Ottaviano (2008) construct a variable markup model in analyzing the relations among market size, productivity, and trade, and prove that market size and trade will affect the intensity of competition and heterogeneous firms’ production decision. Bernard et al. (2007) successfully explain the causes of intraindustry trade and find factors that influence firms’ entry into the export market by introducing firm heterogeneity in a standard trade model. Helpman et al. (2007) create a theoretical model for analyzing MNCs’ choice of integration strategy by combining firm heterogeneity with two types of FDI (vertical FDI and horizontal FDI). Manova (2008) integrates credit constraint in the model of Melitz (2003) and finds that firms with higher productivity enjoy advantages in winning export credit support and firms in financially developed countries have easier access to the export market and export more products, particularly in sectors that rely on external financing.
2.3.2 Endogenous Boundary Model of the Firm There are two basic models of firm boundary. One is to apply the transaction cost theory of Coase and Williamson to the study of business internationalization; the other is to adopt the property right analysis method of Grossman et al. (2003) combines the Grossman Hart Moore firm theory with the Helpman Krugman new trade theory in the same analytical framework and proposes a model of incomplete contract and property right model concerning firm boundary to analyze MNCs’ positioning and control decision, which marks the starting point of the endogenous boundary model of the firm. The model defines MNCs’ boundary and the international position of production and can be used to predict the type of intrafirm trade. Inspection by variables show that the qualitative and quantitative characteristics of the model and data are consistent. Antras and Helpman (2004) combine the trade models with heterogeneous firms proposed by Melitz (2003) and the endogenous boundary model of the firm proposed by Antras (2003) to create a new theoretical model that analyzes firms’ behavior in international business from their differences in organizational structure and concludes that the decisions on outsourcing or integration, operating at home or abroad, etc. are all firms’ endogenous organizational choices. Antras (2005) creates a dynamic generalequilibrium model of North South trade to explain the appearance of product life cycle caused by the incompleteness of international contracts. Antras and Helpman (2006) generalize the international production organization model with heterogeneous firms proposed by Antras and Helpman (2004), introduce contractual frictions in the model, and allows for their varying degrees according to inputs and country. This model suggests that firms’
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productivity level would influence their strategic choice of organizational form.7,8 In general, the endogenous boundary model of the firm proceeds from the organizational choice of individual firms and combines international trade theory with firm theory in the same framework. It marks a further development in the trade theory with heterogeneous firms and offers a brand new perspective for the research into firms’ globalization and industrial organization. The endogenous boundary model of the firm is typically started by the studies of Antras (2003) and Antras and Helpman (2004), examines firm heterogeneity’s influence on the strategic choice of outsourcing and insourcing, and explores how firms’ organizational form affects trade model.
2.3.3 Interpretation of Global Production Networks in “New” New Trade Theory The “new” new trade theory is highly consistent with microcosmic GPN studies. The inclusion of the theory in the GPN framework provides a new microbasis and new perspectives for the research into GPNs. The theory can explain the heterogeneity and power asymmetry of firms in GPNs, including the behavioral pattern and inner traits of firms and productivity, technology, and workers with heterogeneous skills as the sources of heterogeneity. In conjunction with the fixed costs of trade, the theory can explain firms’ productivity differences, and be used to analyze the influence of firms’ organizational form on international trade and GPNs and in particular, the features and causes of international trade within MNCs, thus enriching the research into GPNs. The “new” new trade theory mainly explains the following issues about GPNs: what kind of firms would create GPNs to serve international markets; what organizational forms would they choose (export or FDI, horizontal or vertical FDI, creation of new business or cross-border M&A, and outsourcing or integration); how do they choose locations (domestic or international and South or North); can GPNs improve firms’ performance and competitiveness. Therefore, the “new” new trade theory offers significant support to microcosmic GPN studies. The “new” new trade theory proceeds from firm heterogeneity in explaining the benefits of GPNs. Countries and regions that lag behind should be actively involved in the international division of labor and raise the level of openness to the outside world, which will help enhance industry productivity and promote local economic development. The theory finds a new way of improving productivity. Under the condition that the productivity of 7. This does not include the export of foreign-funded enterprises since only the behavior of domestic enterprises is the subject of study here. 8. According to the market clearing condition, it can be concluded that the output of the firm is “A(a/α)A/α ε,” total income “A(a/α)A/α1 ε,” and variable costs “αA(a/α)A/α1 ε.”
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individual firms stays unchanged, a country can still raise the level of productivity in an industry and even across all sectors through trade and opening up. It also suggests that GPNs may have negative impacts on less developed regions. Opening the market may plunge industries with lower efficiency in less developed regions into recession and industries entering less developed regions may be industries with low productivity and high environmental costs. Business relocation may lead to a reversion in small countries’ productivity gains while helping increase big countries’ productivity gains. GPNs lead to the reallocation of resources and the shift of profit and market share to firms with high productivity, which may cause excessive resource monopoly and thus loss of efficiency in the entire market.
2.4 SUMMARY This chapter focuses on three basic theories important to microcosmic GPN studies, including MNCs theory, new classical trade theory, and “new” new trade theory, as well as their interpretation of GPNs. The MNCs theory can explain such issues as the formation and evolution of GPNs; network participants and their relationships; internal mechanism and conditions of MNCs’ integrated expansion; operation mechanism and dynamic governance of networks; spatial characteristics of networks and their relations with regional economy, scale, and form of GPNs; and boundary of the firm. The new classical trade theory with the division of labor and specialization at the core can analyze the economic reality that GPNs as a new way of organizing production is growing in popularity from a more rigorous and standard perspective of economics. It explores technology transfer and spillover, trade in intermediate goods and inputs, trade and economic growth, industrial upgrading, increase in employment, MNCs’ industrial organization and gains from trade on the microlevel. This will lead to different explanations about key issues such as the causes, models, and outcomes of trade from those offered by traditional international trade theory. The “new” new trade theory is highly consistent with microcosmic GPN studies, and can explain the heterogeneity and power asymmetry of firms in GPNs, and firms’ productivity differences. It can be used to analyze the influence of firms’ organizational form on international trade and GPNs and in particular, the features and causes of international trade within MNCs, thus enriching the research into GPNs. In short, these basic theories are of crucial importance to microcosmic GPN studies.